How Does the IRA Rollover 12-Month Rule Work?
Understand the IRA 12-month rule, how it applies specifically to indirect rollovers, and why all of your IRA accounts are aggregated for this regulation.
An Individual Retirement Arrangement (IRA) allows for the movement of retirement funds between different accounts, a process known as a rollover. These transactions provide flexibility for managing retirement savings, such as consolidating accounts or seeking different investment options. The Internal Revenue Service (IRS) has established specific regulations to govern these movements of funds.
A primary regulation is the one-rollover-per-year rule, which imposes a limit on how frequently an individual can move funds between their IRAs. Understanding this rule is important for any IRA owner considering a rollover to avoid unintended tax consequences.
Defining the One-Rollover-Per-Year Rule
The one-rollover-per-year rule, outlined in Internal Revenue Code Section 408, restricts a taxpayer to one IRA-to-IRA rollover during any 12-month period. This limitation is designed to discourage the use of IRA funds for short-term loans and targets a transaction known as an indirect rollover. An indirect rollover occurs when an individual takes a distribution from their IRA and redeposits the funds into another IRA within 60 days.
This rule does not apply to all types of fund movements. A direct rollover, also called a trustee-to-trustee transfer, is exempt from this limitation. In a direct transfer, funds move from one financial institution to another without the account holder ever taking possession of the money. Because the individual does not have access to the funds, the IRS does not count this as a rollover for the purposes of the 12-month rule.
How the Rule is Applied
The application of the one-rollover-per-year rule involves two mechanics. The first is the timing of the 12-month period, which is not a calendar year. It is a rolling 12-month period that begins on the date the taxpayer receives the distribution from the first IRA, for instance as a check or a bank deposit. For example, if a distribution is received in March, another indirect rollover cannot be initiated until the following March.
Another element is the IRA aggregation rule from IRS Announcement 2014-15, which treats all of an individual’s IRAs as a single IRA for this rule. This includes Traditional, Roth, SEP, and SIMPLE IRAs. A rollover from any one of these accounts to another of the same type starts the 12-month clock for all of them. For instance, an indirect rollover from a Traditional IRA prevents a separate indirect rollover from a Roth IRA within that same 12-month window.
Transactions Not Subject to the Rule
Several types of retirement account transactions are not subject to the one-rollover-per-year limitation. Rollovers from an employer-sponsored retirement plan, such as a 401(k) or 403(b), into an IRA are not limited. An individual can roll over funds from a former employer’s plan into an IRA at any time, regardless of any IRA-to-IRA rollovers they may have completed.
Another exception is a Roth conversion. This is the process of moving funds from a Traditional, SEP, or SIMPLE IRA into a Roth IRA. The IRS treats this as a taxable conversion, not a rollover, so it does not count toward the one-rollover-per-year limit.
Consequences of a Violation
Violating the one-rollover-per-year rule results in tax consequences. If a second IRA-to-IRA rollover occurs within the 12-month period, the transaction is disallowed. The amount withdrawn for this second rollover is treated as a taxable distribution and must be included in the taxpayer’s gross income for that year.
Beyond income tax, the disallowed rollover amount may be subject to a 10% early withdrawal penalty if the taxpayer is under age 59½. If the disallowed funds were deposited into another IRA, the amount is considered an excess contribution.
Excess contributions are subject to a 6% excise tax for each year they remain in the account. This penalty tax is reported on IRS Form 5329, “Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts.” To avoid this recurring penalty, the excess contribution and any earnings it generated must be withdrawn by the individual’s tax filing deadline for the year of the violation.