Global View Investment Blog

When You Don’t Qualify for a Roth IRA …

A Roth IRA offers many benefits, but not everyone can contribute to one … or can they?

A Roth IRA has income restrictions. Congress placed limits on contributions to a Roth account based on the Modified Adjusted Gross Income (MAGI) you report on your tax return.

Roth MAGI-based contribution limits phase in at set thresholds based on your filing status. (Traditional IRAs do not have income restrictions, but they do have deductibility limits.) Roth MAGI limits are inflation-adjusted, and for 2021 consist of the following: 

  • If you are married filing jointly or are a surviving spouse, you can contribute the full amount to your Roth IRA in 2021 if your MAGI is less than $198,000. If your MAGI is between $198,000 and $207,999, the amount you can contribute is reduced, and you’re barred from contributing when your MAGI exceeds $208,000.
  • For married filing separately, the MAGI limit reduces your contributions for the first $9,999 earned and bars them at earnings of $10,000 or higher.
  • If you are single, a head of household or married filing separately and you did not live with your spouse at any time during the year, the MAGI limit begins to reduce contributions if your MAGI is $125,000 and bars them once you earn $140,000.

The most you can contribute to an IRA in 2021 is $6,000 (or $7,000 if you’ve reached age 50). You can split up your contributions among several Traditional and Roth IRAs as long as your total contribution doesn’t exceed the limits. The amount of reduction in the intermediate brackets can be calculated using a worksheet in IRS Publication 590-A.

You might find a Roth IRA’s tax-free growth and distributions very attractive, but your high income may restrict you from contributing to one. Unless, however, you do a Roth conversion. This strategy is a well-known loophole that allows you to roll-over as much as you’d like to a Roth IRA (there is no limit on rollovers to an IRA), regardless of your income.

However, this isn’t always the right move. The Global View team helps many high net worth clients planning on retiring in Greenville, SC (or anywhere, for that matter) navigate the Roth conversion process. (This can be especially beneficial if you got a late start to your retirement planning.) If you, too, are considering a Roth conversion, it’s important to fully understand how it works to determine whether it’s a good idea.


Retirement planning can be complicated. Schedule a no-obligation conversation with the Global View team to see how we can help.


How a Conversion Can Override Income Restrictions

You can work around the Roth MAGI restrictions by first contributing to a Traditional IRA or other qualified retirement account and then moving the money into a Roth IRA through a process called a conversion. Here’s how it works: 

  1. Fund your Traditional IRA and/or 401(k) up to the maximum amount. If you don’t have a qualified retirement account, you’ll have to open one first.
  2. Convert the money from your Traditional retirement account to a Roth IRA.
  3. Prepare to pay taxes on the amount converted, as Traditional retirement account contributions are made with pre-tax money, and a Roth account is not.
  4. When you file your tax return, include IRS Form 8606 to report the Roth conversion.

There are two ways to convert the money: Either directly or indirectly. The most straight-forward way is directly, or through a trustee-to-trustee rollover from one financial institution to another. (If both accounts are at the same institution, you can arrange a same-trustee transfer.) In this scenario, the money is never technically in your hands, so there should be no confusion when it comes to taxes. The second way is indirect, in which your current plan holder cuts you a check, and then you deposit the money into the Roth account. There is a 60-day deadline to complete a rollover, so if you fail to make that deadline, the IRS will consider the money a withdrawal and you will face taxes and potential penalties for an early withdrawal.

Work with a financial advisor to avoid any missteps. Mistakes can be expensive!


Benefits of a Roth IRA

Even though it can be a slight hassle to convert your Traditional retirement funds to a Roth IRA, it can be worth it to you for a number of reasons: 

  • Roth IRA earnings grow tax-free.
  • Withdrawals of Roth contributions are tax-free.
  • Withdrawals of Roth earnings are tax-free, as long as you follow the rules (see Drawbacks section below).
  • You don’t have to withdraw money from your Roth IRA during your lifetime, which allows you to pass the money to your heirs tax-free.

You’ll find a Roth conversion most beneficial under certain circumstances: 

  • You can afford to pay the taxes without dipping into the Roth funds. This tax bill can be quite large, depending on the amount you’re rolling-over. If you were to pay the taxes using conversion money, you may have to pay a 10 percent penalty on any amount diverted away from the conversion.
  • You have losses in your Traditional IRA. By converting when your IRA value is lower, your tax bill be lower. You’ll then have a greater chance of higher tax-free growth in the Roth IRA when prices recover.
  • You happen to be in a lower-than-usual tax bracket in the year of conversion. Perhaps you had business losses, interrupted earnings or an unusual number of itemizable deductions, or you were hit with a court order to pay alimony. Converting when your tax bracket is low can be make the process more affordable.


Drawbacks of a Roth Conversion

There are a few drawbacks to a Roth IRA conversion. 

  • You will have to pay taxes on the converted funds (except for non-deductible contributions) and those taxes can be significant.
  • If your tax rate declines later in life, the benefit of a tax-free distribution is reduced.
  • You must wait five years before you can take a tax-free withdrawal of earnings from your Roth IRA, or face a 10 percent penalty on top of the income tax bite.
  • You’ll have to pay taxes and a penalty if you withdraw earnings from a Roth IRA before reaching age 59-½. However, certain exceptions apply that may save you the penalty tax.


Is a Roth Conversion Right for You?

A Roth conversion can be complicated, and mistakes can be costly. Talk to a financial advisor about what it looks like for your situation.

If you’re retiring in Greenville, SC, Global View is a fee-only, fiduciary financial advisory firm headquartered in Greenville, South Carolina with offices in Charleston and Columbia, SC that can serve investors nationwide. Our mission is to be our clients’ advocate. We provide truly independent, conflict-free advice and complete wealth management services, so you can protect and maximize the wealth you’ve built.

If you have a question about Roth IRAs or would like to discuss your specific situation in more detail, schedule a no-obligation conversation with the team at Global View to see how we can help.


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Adam Wiles

Written by Adam Wiles

Adam is a Partner at Global View. Adam’s primary focus is on investment strategy, retirement planning, risk management, and new client identification. He has extensive experience and training in identifying client’s needs and explaining the solutions that meet those needs. He worked with Merrill Lynch for 2 years prior to joining Global View. Prior to Merrill Lynch, Adam worked 10 years, in several trading capacities, within the Commodity Lumber business.

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