How do I fix a 60-day rollover missed deadline?
I recently rolled over my 401(k) account on my own. My retirement gross amount was $750,000 but I received $525,000 after the tax withholding. I didn't rollover the money to an IRA by the deadline so I missed the 60-day window. Our annual income from work will be over $100,000 including my wife's salary and we jointly file taxes.
What will be my tax bracket? Is the retirement income also include as annual income? Do I need to pay tax again for the retirement amount? Please Let me know.
Can I roll over some money to an IRA since it seems to be taxable?
Joshua Escalante Troesh, CFP | MBA
The Dangers of Rolling Over 401(k) or IRA On Your Own
I am so sorry this happened to you. Unfortunately, your situation is a common one for people when they retire or change jobs and move their 401(k) account. Handling this rollover on your own creates a lot of tax problems, even if you do everything perfectly. Below are some ideas to help you, but first the answer to your initial tax questions.
What Happens to Taxes
When you miss the window, you created taxable income for the year in the amount of the retirement account balance. Based on what you described, your gross income for the year will be $850,000 – consisting of the $100,000 of actual income plus the $750,000 of income created by the ‘withdrawal’ of the retirement account. This would put your marginal tax bracket at 37% for approximately $130,000 of the $850,000.
You will not owe the entire tax amount, as 20% of your retirement account balance (~$225,000) has already been sent to the IRS as a tax withholding. You will only have to make up whatever else may be owed based on the rest of your tax filing. I’ll give some potential solutions below, but first I want to explain the mechanism of what happened so you have the context.
Rollovers With an Adviser’s Help
When you move money from one retirement account to another [such as rolling money from a 401(k) to an IRA], there are three possible methods. The first two are the methods financial advisors use to roll accounts over, which is either a direct rollover or a trustee-to-trustee transfer.
The details of each vary, but the important thing is the advisor sets up your new account and has the money transferred directly to the custodian of the new account (a large institution, not the advisor). Because the money stays within your two accounts, the IRS treats it as though you never touched the money even though you are the owner of both accounts. This means the rollover happens with no tax implications.
Doing a 401(k) or IRA Rollover On Your Own
When individuals transfer (rollover) their retirement accounts on their own it is done through an indirect rollover. This is the situation you experienced. In an indirect rollover a check comes to you for 70% to 80% of the account balance. Your employer withholds 20% of the account (plus possibly a 10% early withdrawal penalty) and sends that money to the IRS. You then have 60 days to deposit 100% of the original account balance ($750,000 in your case) into a new IRA. Or said another way: you have to magically come up with 20% or more of the account balance ($225k) out of thin air within 60 days.
If you complete all of this on time, the money the IRS received from your employer will be returned to you when you file your taxes next year. For this reason, I never recommend anyone doing an indirect rollover on their own. Even if you do it perfectly, you still have to come up with 20% to 30% of the retirement account balance out of your own pocket and you don’t get it back until next year.
Fixing an Indirect Rollover
Fixing an indirect rollover can be challenging. The first thing you want to check is if you are still within the 60-day window. The 60-day window doesn’t start from when you requested the rollover, it starts from when you had constructive receipt of the money. This means if you haven’t cashed the check, and other circumstances happen to align, you may be able to get the entire amount back into an IRA and undue everything.
This is not something you should attempt on your own and you should have a fiduciary financial advisor and a CPA help you with the process. The financial advisor would lead this process and your CPA would provide tax guidance, (hopefully) their blessing, and the filing of your taxes in the following year. If either advisor says it’s a no-go, then it won’t work.
Making Up The Lost Retirement Account Balance
If you are past the 60-day window, there is no way to put the money directly back into a retirement account. Your next option would be to minimize the tax impact by increasing contributions to your retirement accounts in future years. While this isn’t going to solve the entirety of the problem for you, it can help minimize the long-term tax impact. The best case scenario is if the rollover happened this year, but even if the rollover happened last year the strategy will help over the long-run.
Depending on your and your wife’s age, you could contribute as much as $52,000 of the money back into retirement accounts annually assuming both you and your wife have 401(k)s at work. (This figure adjusts for inflation). And if either of you work for a government agency or are a small business owner, it is possible to get much more than that back in annually. While this won’t solve the problem, it can minimize the damage.
The Coronavirus RMD - Reversing an RMD in 2020
Finally, there is an unlikely strategy which has minimal impact, but every little bit helps. Based on the numbers you provided, I am going to assume you are younger than 59.5. This means the last strategy isn’t applicable – but in the off chance you are age 72 or older you can get a small portion of the money back into the IRA. If you are subject to Required Minimum Distributions, the IRS recently released guidance for rolling RMDs back into IRAs for 2020 only based on the Coronavirus pandemic. This means for the
RMD amount only, you could undo a tiny part of the rollover.
Difference in Managing Taxable Investments vs. Retirement Investments
One final note, regardless of the circumstances, you will need to manage the money now that it is out of the retirement account. Since it is now subject to taxes, you will want to pay attention to the impact of taxation on the investment choices. This would include the income the investments generate, the impact of the Alternative Minimum Tax, capital gains treatments, and imbedded gains within any mutual funds you choose among other considerations. Investment management of a taxable brokerage account isn’t the same as retirement accounts.