By Andy Ives, CFP®, AIF®
The “Martin Scenario”: Martin, age 40, has never done an IRA rollover before. He took a distribution from his traditional IRA in December 2021 for $10,000 and deposited it into his checking account. Martin took another distribution from his IRA in January 2022 for $50,000. He also deposited this into the same checking account.
Trivia Question #1: Does the fact that Martin commingled both IRA distributions into his checking account present any problems for a future rollover?
Answer: It does not. There are no rules precluding a person from combining an IRA distribution with other accounts or using the money while it is out on rollover for 60-days.
Question #2: Can Martin roll over both the $10,000 and the $50,000 distribution?
Answer: No, he cannot. That would violate the one-rollover-per-year rule. Also, he cannot consolidate the distributions and roll over one $60,000 amount. The one-per-year rule is based on the number of distributions, not the number of rollover deposits.
Question #3: Since the $10,000 distribution came out first, is that the only distribution that can be rolled over?
Answer: No. Since both distributions were taken within the previous 60 days, Martin can choose which distribution gets rolled over. As long as he completes a rollover within 60 days, he can rollover any amount up to $50,000.
Question #4: If Martin elects to roll over the $50,000, is he stuck paying the taxes AND the 10% early withdrawal penalty on the $10,000 early distribution?
Answer: Not necessarily. If Martin rolls over the $50,000 and no other exception applies, then yes, taxes and the penalty on the remaining $10,000 will apply. However, if he is still within the 60 days, Martin could deposit the $10,000 into a Roth IRA. This will qualify as a valid Roth conversion. The taxes will still be due, but there is no 10% penalty on a Roth conversion. Additionally, Roth conversions do not count against the one-rollover-per-year rule and can be done in an unlimited amount annually.
Question #5: Does the fact that Martin took the $10,000 distribution in December and converted it to a Roth IRA in January present any problems?
Answer: Crossing calendar years with rollovers or conversions is perfectly acceptable. However, it will create some tax reporting matters. Martin will receive a 1099-R for 2021 showing the gross $60,000 distribution. IRS Form 5498 showing the rollover and Roth conversion in 2022 will not be released until early 2023. Fortunately, the 5498 is not needed to file his taxes. Martin will indicate on his 2021 return that the $10,000 was converted to a Roth and the $50,000 was rolled over, and the IRS will receive confirmation of the transactions next year when the 2022 5498 is sent to them by the custodian.
The “Martin Scenario” is relatively basic, but the different pitfalls and possibilities for what happens after an IRA distribution are mind numbing. Be sure to know the rules and repercussions before executing any IRA transaction.