Posts

Print Friendly Version Print Friendly Version

Failed Rollovers

An advisor asked:

“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?”

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.

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.

© Copyright 2021 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Three’s A Crowd Regarding IRA Rollovers

By W. Andrew Larson, CPC

The Securities and Exchange Commission (SEC) finalized new rules (known as Regulation Best Interest or Reg. BI) that address, in part, IRA rollovers for broker-dealers.  This commentator questions the wisdom of inserting now a third governmental agency into the retirement space, which, historically, was overseen by the IRS and Department of Labor (DOL). It seems that if Congress had wanted the SEC in this regulatory mix it would have said so in the first place. I wonder if the SEC has such ample resources it feels impelled to expand their regulatory purview or if, perhaps, this is an attempt to obtain additional funding for these new endeavors.

Under Reg. BI, broker-dealers are held to a best interest standard when making a recommendation to a retail customer. In this context, a “retail customer” does not include a plan sponsor, but it does include plan participants with regard to recommendations to take distributions or roll over assets to IRAs. Arguably, advisors are required to demonstrate how they arrived at a best interest finding and recommendation. Effectively, this regulation is a watered-down version of the vacated DOL fiduciary rules and, while the objective of protecting consumers is admirable, my concern is the propriety of injecting another federal agency into the arena of Employee Retirement Income Security Act (ERISA) enforcement.

The General Obligation of Reg. BI has four components:

  • Disclosure of the relationship and fees (Disclosure Obligation);
  • Duty of care (Care Obligation),
  • Mitigation and disclosure of conflicts (Conflicts of Interest Obligation); and
  • Establishment, maintenance and enforcement of policies and procedures (Compliance Obligation).

The SEC has noted certain considerations are not considered determinative in and of themselves to warrant a rollover recommendation. For example, having more investment elections available within an IRA vis a vis the qualified plan is not considered enough rationale to conclude a rollover would be in the best interest of the investor according to the SEC.

Factors to consider when contemplating a rollover should include items such as, but not limited to, the following:

  • Fees and expenses;
  • Level of service available;
  • Availability of retirement income products and other investment options;
  • Ability to take penalty free withdrawals;
  • Protections from creditors and legal judgments;
  • Administrative convenience;
  • Beneficiary considerations (some qualified plans don’t allow the full range of beneficiary options permitted under statute);
  • Availability of net unrealized appreciation (NUA) opportunities with employer stock,
  • After-tax contributions and the potential for Roth conversions;
  • Required minimum distribution (RMD) requirements (e.g., Designated Roth accounts in 401(k) plans remain subject to RMD requirements); and
  • Any special features of the existing account.

Ultimately, I believe Reg. BI will result in a more nuanced IRA rollover recommendation process where “all or nothing” rollover events will become less common. Future recommendations involving plan distributions and rollovers will require advisors to have a greater understanding of their customers’ retirement plans, and the options and choices among the various money types within the plans. For example, 401(k) arrangements are highly variable by sponsor, each having multiple money types, features and provisions. Clearly, the first step in the Duty of Care process is having a thorough understanding of the distributing plan’s applicable provisions and features, and securing documentation that would support the basis for making any recommendations. But sources for detailed plan information are limited.

Retirement Learning Center (RLC) has a library of over 6,000 plan documents it has analyzed and summarized as “Plan Snapshots,” which can give advisors important plan information necessary to feed the Duty of Care process. Use of RLC’s plan information not only saves time but can be part of the crucial documentation necessary to support a recommendation.

With oversight from the IRS, DOL and now SEC, the rollover landscape is changing and will result in advisors taking a more subtle, thoughtful and documented approach with investors when recommending retirement plan distributions and rollovers.

 

© Copyright 2021 Retirement Learning Center, all rights reserved