Avoid Rollover Tax Traps

You can defer the tax on withdrawals from a qualified retirement plan or IRA by rolling over the funds into another qualified plan or IRA within 60 days. To avoid unintended tax consequences, be sure to follow the rollover rules to the letter.  Following are two tax traps to avoid.  There are others, however, so when in doubt, consult a tax advisor.

Cash Out, Cash In
To qualify for rollover treatment, you must contribute "the same money or the same property" to the new account.  If you withdraw cash from one account, you must contribute cash to the new account (although generally there are no restrictions on the use of the funds during the 60-day rollover period).  In a recent Tax Court case, one investor learned this lesson the hard way.  He withdrew almost $500,000 from his IRA and Keogh plan, used the funds to purchase stock, and then contributed the stock to a new IRA within 60 days.

The Tax Court denied rollover treatment because the taxpayer withdrew cash but contributed stock.  The taxpayer was liable for income taxes and a 10% early withdrawal penalty on the entire amount.  Lemishow v. Commissioner, 110 TC 11 (1998).

Regular-to-Roth IRA Rollover
Taxpayers with adjusted gross income (AGI) of $100,000 or less (except for married taxpayers filing separately) may roll over an existing IRA into a Roth IRA without early-withdrawal penalties.  Such a rollover is subject to income tax, but for rollovers during 1998 this tax may be spread over a four-year period.

If you're contemplating a regular-to-Roth IRA rollover, plan carefully.  Unless you're sure your AGI won't be more than $100,000 for 1998, it's probably best to wait until the end of the year.  If you make the rollover sooner and your income exceeds the threshold, you'll lose the four-year spread and, if you're under age 591/2, you'll be subject to a 10% early withdrawal penalty.

To avoid this trap, wait until year-end (e.g., December 31) to take a distribution from your regular IRA.   Once you've determined your income for 1998, contribute the funds to a new Roth

IRA (if you qualify) or roll the funds back into a regular IRA within 60 days.  Note:  If you complete the regular-to-Roth IRA, you'll still qualify for the four-year spread, which only requires that you begin the rollover in 1998.