Rollover IRA accident

[Blake13]

Hi,

I am getting married this year and my bride and I both had 401k's from previous companies. I wanted to get everything figured out and consolidated. So I opened a rollover IRA and deposited her 401k into my rollover. She only had 2k in her 401k from her previous employer. Then I find out that I needed her to open her own rollover IRA and shouldn't deposit her funds into mine. It does not exceed my max contribution.  This was a mistake and I am wondering if I have to file Request a Recharacterization form and have her open her own account. I understand she should probably have her own anyways, but I really would prefer not to file this form anyways if it wont affect my taxes.

Best,

[Opus 17]

As you have learned, 401k and IRA funds are individual and belong to one person only, and funds from more than one person can never be combined, even if they are spouses.  

As of now, if you don't change anything, what you have is a withdrawal from your spouse's plan, that is taxable income plus a 10% penalty for early withdrawal (assuming your spouse is under age 55).  Then, you have a $2000 deposit into an IRA in your own name, which might be tax deductible depending on your employment situation and other income.

You have the option of withdrawing contributions from your own IRA up to the tax filing deadline, if this happened in 2022, then you have until April 15, 2023 to withdraw the funds.  Simply tell the IRA bank that you made a mistake and want to withdraw the funds, it's not a recharacterization.  If you have gains (growth) from the mistaken contribution, you also must withdraw those gains, and the gains will be taxable plus the 10% early withdrawal penalty.

However, if more than 60 days have passed since the 401k withdrawal, you can't re-deposit the funds into an IRA in your spouse's name and call it a tax-free rollover, so your spouse will still pay income tax plus the 10% penalty on the withdrawal.  

If you are eligible to contribute $2K to your own IRA, then I would probably leave things as-is.  The tax deduction on your $2K IRA contribution will offset the income tax on your spouse's $2K withdrawal, and you will be left with the 10% penalty, but there is no way to avoid that.  Then separately, your spouse can open an IRA in their own name and make tax-deductible contributions so you each have separate retirement funds.  If your spouse doesn't have compensation from working, she can still make IRA contributions by relying on your compensation.  (Note that all IRA contributions are subject to rules based on income and employment status that you must follow.)

[NCperson]

@Blake13 -did she cash out her 401(k),receice a check, deposit it in bank  and then you sent a new check (presumably with your name on it) and deposit it into your IRA?

or was a check issued by her administrator and that check was presented to the incoming adninistrator of the IRA...

it may make a difference on how you approach this.

Also, are you still within 60 days from the time the money came out of her 401(k)? 

[Opus 17]

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@NCperson wrote:

@Blake13 -did she cash out her 401(k),receice a check, deposit it in bank  and then you sent a new check (presumably with your name on it) and deposit it into your IRA?

or was a check issued by her administrator and that check was presented to the incoming adninistrator of the IRA...

it may make a difference on how you approach this.

Also, are you still within 60 days from the time the money came out of her 401(k)? 

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In my answer I assumed the taxpayer received the funds themselves.  I would trust that either the sending plan or the receiving plan would figure out that sending money from a 401k for Jane Doe 556-77-8899 to an IRA for John Smith 123-88-9999 was not permitted and block any direct transfer.

[NCperson]

@Opus 17 

<< I would trust that either the sending plan or the receiving plan would figure out that sending money from a 401k for Jane Doe 556-77-8899 to an IRA for John Smith 123-88-9999 was not permitted and block any direct transfer.>>

one would think this couldn't occur but I thought I'd ask in case the receiving trustee screwed up....and that would change the recommendation on how to fix this. 

[Blake13]

Thanks for the response! She did not cash out her 401k the check was issued by the administrator. This was done like 2 weeks ago

[Opus 17]

@NCperson 

Does it really change anything?  It's still a failed rollover by spouse A into an account not allowed to accept a rollover from spouse A.  Spouse A still owes tax and the penalty.  I don't think the tax laws have an out for trustee mistakes, unless you already know of such an exception.  Although they might have a malpractice claim against the receiving custodian to pay the penalty.

[Blake13]

Hi! Thank you for the reply and help. Thats what I would have thought too, but it allowed me to deposit the funds into my account even though it was issued to her name

[Blake13]

Agreed, that makes sense and thank you for the help! I am going to open a rollover IRA account for her and see if I can file Request a Recharacterization form to try and get it back to her account and not try to avoid any potential penalties. 

[Opus 17]

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@Blake13 wrote:

Thanks for the response! She did not cash out her 401k the check was issued by the administrator. This was done like 2 weeks ago

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How did she get a check if she did not "cash out"?  Now you are confusing me.  Maybe the plan issued a check because she quit the job and her balance was small enough that they closed her account out automatically.  So it wasn't her request, but the 401k was still closed.

And you have plenty of time to fix this if it only happened 2 weeks ago.

Let me attempt to clarify.  Please correct if I am wrong.

1. Bride received a check from the 401k plan.

2. Groom deposited an equal amount of funds into an IRA owned by the groom.

3. Groom may also have rolled over funds from groom's old workplace plans into groom's IRA.

So this is what needs to happen.

1. Bride opens an IRA in bride's name and deposits an amount equal to the check from bride's 401(k).  Bride informs IRA custodian before sending funds that this is a rollover from a 401(k).  This must be completed within 60 days from the original 401k withdrawal.  The money can come from anywhere, it is not necessary for it to be the exact same dollars withdrawn from the groom's IRA.  (Because, once you receive money in the form of a check or bank deposit, it loses it's "source" and is just "money" with all your other money.)  Doing this within 60 days makes this a legal and correct rollover.

1a.  Bride will receive a 1099-R from the 401k plan detailing the withdrawal.  In the tax program, bride will be asked "what did you do with the money" and one of the choices will be "I rolled it over into a new qualifying account within 60 days."  This will make the withdrawal non-taxable.  

2a. Groom can leave the $2000 deposit in groom's IRA and consider it a tax-deductible contribution.  It doesn't matter that the source was bride's account, because once the check was deposited in the bank, it just becomes generic money.

2b. Or, groom can contact groom's IRA and request for a return of the $2000 because it was a mistake.  Groom does not need to recharacterize it or explain.  You can ask for an IRA contribution to be returned in the same tax year it was made, no questions asked and no explanations needed.  Just say it was a mistake or you changed your mind.  If the original deposit increased in value, that gain must also be returned.  Groom would get a 1099-R for the gain that they report on their tax return and pay income tax plus a 10% early withdrawal penalty. 

[Opus 17]

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@Blake13 wrote:

Agreed, that makes sense and thank you for the help! I am going to open a rollover IRA account for her and see if I can file Request a Recharacterization form to try and get it back to her account and not try to avoid any potential penalties. 

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It's not a recharacterization to take the money out of your IRA.  You are allowed to remove a contribution during the same tax year for any reason.  Just say it was a mistake or you changed your mind.  A recharacterization is something completely different.

[dmertz]

This is a correctable error.  This being a failed rollover, it constitutes a distribution paid to her and an entirely separate contribution by you to your IRA.  The amount is essentially a gift from her to you unless you give the money back to her.

Because the 60-day deadline for an indirect rollover has not yet passed, she can open an IRA and make a rollover deposit to the IRA of the gross amount of the distribution from the 401(k), thus continuing to defer taxes and avoiding any early-distribution penalty.

You could either keep the deposit into the IRA and report it as your own IRA contribution or you could obtain an explicit return of contribution.  Either way, unless she intends this to be a gift to you, you need to reimburse her for these funds.  The amount distributed as a return of contribution will be adjusted for any investment gain or loss, so you might end up either keeping some of this return of contribution or having to supplement it with other funds to give her back an amount equal to the amount erroneously deposited into your IRA.

You'll want to make sure that your IRA custodian reports on Form 5498 the deposit into your IRA as being a regular contribution, not a rollover contribution, otherwise there's a good chance that IRS will flag the discrepancy between the amount reported as distributions from your retirement accounts and the amounts reported as rollovers to your IRA.