Failed Rollovers

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to an invalid qualified-plan-to-IRA rollover. “One of my clients took a distribution from his 401(k) plan and timely rolled it over to an IRA. All good—except that the IRA rollover contained an amount which should have been my client’s required minimum distribution (RMD) for the year. What happens to the RMD in the IRA?”

Highlights of the Discussion

A rollover to an IRA could be a failed or invalid rollover under several circumstances, including if the rollover  

• Includes an RMD;  

• Is made after the 60-day time limit without a valid waiver or extension;  

• Violates the one-per-12-month IRA-to-IRA rollover rule (NA in this case since coming from a plan); 

• Does not meet the definition of an eligible rollover distribution.  

Generally, the IRA owner has a few of options to correct the error pursuant to IRC Sec. 219(f)(6). Your client should seek the guidance of a professional tax advisor for his specific situation. Generally, under current rules,  

1. The IRA owner could leave the ineligible rollover amount in the IRA because the IRS deems such invalid rollovers to be regular IRA contributions for the year. (Of course, the individual, otherwise, would have to be eligible to make a regular IRA contribution for the year and the IRA administrator would need to correct the IRS reporting to reflect a regular IRA contribution). 

2. IRS Notice 87-16 allows an IRA owner to remove any current-year IRA contribution that is an eligible contribution without penalty by following the rules for removing excess contributions with net income attributable (NIA). These contributions must be removed by the tax return due date (including any extensions). 

3. If all or a portion of the invalid rollover amount exceeds the IRA owner’s regular contribution limit, the remaining rollover amount is treated as an excess contribution and will be subject to the six percent penalty tax if not timely removed (i.e., generally, October 15 of the year following the year the excess was created).  

4. Any remaining excess that is carried over in the IRA in subsequent years continues to be treated as a regular IRA contribution until the excess amount is eventually used up or removed.  

Conclusion

When an invalid rollover contribution is made to an IRA during the year, the invalid rollover amount is deemed to be a regular IRA contribution for that taxable year. What happens next depends on whether the amount is an eligible contribution or an excess contribution. See IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)for more guidance.