IRS Simplifies Process For Avoiding Rollover Penalties

As retirement plan processes continue to be more automated, such as enrollments, deferral changes, distributions, loans, etc., many plan sponsors encourage 401(k) plan participants to request a direct trustee-to-trustee transfer or direct rollover. However, participants sometimes do not adhere to this advice and ask to have their account balances distributed directly to them, subject to a 20% mandatory tax withholding. If a participant receives an IRA or retirement plan distribution, they have 60 days from that date to roll it over to another plan or IRA. If the participant fails to do this within 60 days, they may be subject to a 10% tax penalty on top of being taxed on the distribution's full amount.

Previously, participants faced an arduous process to convince the IRS that they had made an honest mistake. With the new procedures introduced by the IRS (Revenue Procedure 2016-47), the IRS now allows participants to self-certify valid reasons to the receiving financial institution. A model letter for taxpayers to use is also provided and describes various scenarios in which participants can avoid the penalty, including the following:

• The financial institution receiving the contribution or making the distribution to which the contribution relates committed an error;
• The distribution was made in the form of a check, which the taxpayer misplaced and never cashed;
• The taxpayer deposited the distribution into an account that he or she mistakenly thought was an eligible retirement plan;
• The taxpayer's principal residence was severely damaged;
• A member of the taxpayer's family died or the taxpayer or a member of the taxpayer's family was seriously ill;
• The taxpayer was incarcerated;
• A foreign country imposed restrictions;
• The post office committed an error; and
• The distribution was made because of a levy and the proceeds were returned to the taxpayer.

Finally, the taxpayer can certify that despite their reasonable efforts to obtain the information, the party making the distribution delayed providing information that the receiving party needed to complete the rollover. This new IRS Revenue Procedure is another example of recent changes to retirement plans that the IRS has produced in order to assist participants with retirement balances.

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