Direct Roth Transfer Error

Submitted by Carlos Oliveira on Wed, 2018-05-23 14:30

A few years ago I attempted a Roth IRA direct transfer from American Funds to Vanguard. I didn’t want to pay the high American Funds fees. The American Funds account (approx. $20,000) was in my then wife’s name. I managed it in every other way. To facilitate that further, I contacted Vanguard to transfer the funds from American to Vanguard. I wanted the Roth now in my name. I was unaware at the time that this couldn’t be done and yet Vanguard did this direct transfer. So, it was now in my name at Vanguard. How serious and illegal is this?

Two years later I was now divorced and we had a separation agreement that gave me this asset in full and we divided up two other retirement accounts between us equitably. I wanted to use some of this money – $17,000 to help bolster a down payment on a new home. It wasn’t necessary for it as I had already $98,000 towards a $213,000 property. I was just trying to reduce my monthly payment from a 20 yr to a 15 yr mortgage. In making this withdrawal, I was under the impression that this Vanguard account had already been established 5 years (going back to American Funds days) and that there was a fair amount of contributions made over the 10 plus years at American Funds so that my tax hit on the $17,000 wouldn’t be as large. A few years later, the IRS sends me a letter informing of the 10% penalty and it now counted as income (as it was taxed all as earnings) and I had a large IRS tax hit.

I made a lot of decisions made on the fact that Vanguard never informed me we couldn’t directly transfer from one Roth to another and change the custodian’s name. I would never have moved it over in the first place or we would have rolled it over in my then wife’s name. I’ve paid back the IRS, but have been in contact with Vanguard to make this right. What should I do as I don’t think they will do more than address IRS issues? They acknowledge their error in the initial transfer? They Acknowledge I made decisions based on false pretenses? They Acknowledge I lost potential long-term compounding interest by withdrawing funds I wouldn’t have otherwise. Yet, I feel like they will do the minimum and not compensate based on the illegal and unethical factors I listed. What should I do? Do I have a case for grievances and should I get a tax attorney to represent me? I’m in the Burlington (Greensboro), NC area.



Submitted by David Mertz on Wed, 2018-05-23 16:18

  • Here is my take on the situation:
  • Because the transfer was not to a Roth IRA in your wife’s name, the transfer failed to qualify as a nonreportable trustee-to-trustee transfer.  Instead it constituted a reportable distribution from your wife’s Roth IRA and a regular (at least partially excess) contribution to your own Roth IRA.
  • It might be possible for your ex-wife to roll the money back into a Roth IRA in your wife’s name under self-certification that this would qualify for a waiver of the 60-day indirect rollover deadline due to believing that the money had been moved to an account qualified to receive the transfer and perhaps financial institution error since the transfer should have been designated by American Funds as being for your wife’s benefit, not for your benefit.  Because the actual result failed to be a trustee-to-trustee transfer, this was reportable as a regular distribution by your wife on the tax return for the year in which the transfer occurred, either as a rollover under self-certification or as not rolled over.
  • Because the actual result was not a trustee-to-trustee transfer, the money deposited into your own Roth IRA was an excess contribution to the extent that it exceeded the amount that you were eligible to contribute for the year in which the transfer occurred.  Portions of the excess might also have been applicable as current-year contributions for each of the subsequent years.  Your tax returns for the year of the transfer and subsequent years should have reported excess Roth IRA contributions.  Because the distribution came from your contribution basis (either regular contributions or excess contributions), your recent distribution should not be subject to tax or penalty.
  • Because the money was already in a Roth IRA in your own name and not in your wife’s name at the time that the separation agreement was made, the agreement did not result in a transfer incident to divorce of the Roth IRA.  All it really did was establish that the asset was to remain yours subsequent to the divorce.  If your ex-wife goes the route of completing an indirect rollover to a Roth IRA, it would need to be done with her own funds from some other source, not from your funds.
  • Vanguard’s only obligation was to complete the transfer to an account for the benefit of whoever was specified by American Funds on the transfer.

Submitted by Carlos Oliveira on Wed, 2018-05-23 22:45

Thank you for taking the time to reply to my situation. I’m debating whether I could take this to a tax attorney to help me navigate all of this. Sounds like the other great reply below indicates it may not be financially worthwhile. I have issues with how this unauthorized direct Roth transfer that switched custodian names isn’t punishable in some way legally. I made decisions that subsequently were based on a faulty transfer and have paid dearly for it. But, if you all don’t think this is a path I should pursue, then I guess just sticking to the nuts and bolts of the tax implications is what needs to be done. 

Submitted by Carlos Oliveira on Wed, 2018-05-23 23:01

Also, I did not have an existing Roth account at Vanguard when the transfer was made from American. A new account was created specifically for this transfer and I wasn’t advised we couldn’t do a direct transfer and simply change the custodian’s name without any tax implications. I’m aware of that now, but at the time you’d think that important nugget of information would have been communicated for this type of transfer. That’s why I’m hokding Vanguard responsible for failing to communicate this to set off the mess in motion. Do I have a case here?

Submitted by David Mertz on Thu, 2018-05-24 00:04

  • You appear to be referring to yourself as the “custodian.”  You are the account owner or participant.  American Funds and Vanguard are the account custodians or trustees.
  • It’s not entirely impermissible for a transfer to be made from the IRA of one spouse to an IRA of another spouse because a transfer of an IRA incident to divorce is done this way.  However, your transfer was not a transfer incident to divorce since the transfer occurred before there was any approved separation agreement.  If Vanguard was aware that the transfer was from the account of another individual, they probably should have asked for confirmation that the transfer was incident to divorce, but, while a reasonable expectation, I don’t know that they had a legal obligation to do so.  Similarly, in the absence of any indication that this was a transfer incident to divorce it might have been appropriate for American Funds to have questioned receipt of a request from Vanguard to make a transfer to an account for the benefit of a different participant, but, again, I don’t know that they had an obligation to do so.

Submitted by Alan - IRA critic on Wed, 2018-05-23 16:33

  • With an unprecedented mess like this, you have to establish a starting point. Did this attempt to transfer her Roth to you reflect an intent to do an amicable property settlement at the time? What year was this?
  • Is Vanguard going to accept any responsibility for the error? Do they have any advice other than to see your tax advisor? They will probably not offer anything and the amount here is too low for you to throw good money after bad and pay legal fees that would well exceed the amount in question.
  • As for the IRS, they are going to react to the 1099R forms they receive, but no 1099R was issued for the transfer so the IRS is not aware of the transfer error or the distribution that took place due to disallowed transfer, nor was a 5498 issued to report a 20,000 contribution in your name, which is an excess contribution to the extent it exceeds what you otherwise could have contributed that year. There is no statute of limitations on excess contribution and a 6% excise tax is owed for each year the excess remains. This is what the IRS would expect if you decide to report the excess contribution. Note that you have withdrawn 17k. so only a 3k excess amount remains. What you do will also affect how you report the latest distribution. The problem here is that what is done regarding each transaction sends you down a different path. The divorce is another fork in the road, and I assume you do NOT wish to amend any old joint return or open up issues with ex spouse and attorney.
  • As for the current tax bill on your 17 distribution, that was likely caused by your not filing Form 8606 to report the distribution. That said, you need to make a decision how you would complete that 8606, since your Roth contained an excess contribution at the time and perhaps some other amounts in your Roth from other contributions?

 

Submitted by Carlos Oliveira on Wed, 2018-05-23 22:51

Thank you for your reply. This initial transfer was made befire we even discussed a seParation. The two part transfer of the $20,000 funds from American to Vanguard were made in Dec 2010 and jan  2011. We were not officially separated Until March 2011. This asset was in my name at divorce time and was mine to keep in the distribution of two other retirement accounts that were split equitably between us. If it had been in her name at the time, it still would have been mine to balance out the other two retirement assets. I would just have had to wait post-divorce to access it like we did part of her 401K. So, Vanguard switching custodians screwed me over once I accessed the $17,000 for a down payment on a home and it came to light for the IRS.  

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