Glossary term
Pro-Rata Rule
The pro-rata rule requires IRA distributions or Roth conversions to include a proportional mix of pretax money and after-tax basis.
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What Is the Pro-Rata Rule?
The pro-rata rule is the IRA tax rule that treats a distribution or Roth conversion as coming proportionally from pretax IRA money and after-tax IRA basis. A taxpayer generally cannot choose to convert only the after-tax dollars while leaving pretax IRA dollars behind.
The rule is especially important when someone has made nondeductible traditional IRA contributions and also owns pretax traditional, SEP, or SIMPLE IRA balances.
Key Takeaways
- The pro-rata rule allocates IRA distributions between taxable and nontaxable amounts.
- It looks across traditional, SEP, and SIMPLE IRAs, not just one account.
- Form 8606 tracks after-tax basis and helps calculate the taxable portion.
- The rule can make a backdoor Roth IRA conversion partly taxable.
How the Calculation Works
The basic idea is proportional treatment. If part of the total IRA value is after-tax basis and part is pretax money, each distribution generally carries the same blend. Form 8606 is used to report nondeductible contributions and calculate the taxable and nontaxable portions.
After-tax basis is the amount of nondeductible IRA contributions already taxed. Total IRA value generally includes the relevant traditional, SEP, and SIMPLE IRA balances used in the Form 8606 calculation.
IRA money type | How the rule treats it |
|---|---|
Nondeductible contributions | Create after-tax basis that may be recovered tax free over time. |
Deductible contributions | Generally taxable when distributed or converted. |
Tax-deferred earnings | Generally taxable when distributed or converted. |
Roth conversion | Can include both taxable and nontaxable portions under the rule. |
Backdoor Roth Context
The pro-rata rule is a common surprise in backdoor Roth IRA planning. A taxpayer may contribute after-tax money to a traditional IRA intending to convert it to Roth. If the taxpayer also has pretax IRA balances, the conversion may not be tax free because the rule treats the conversion as coming from the combined IRA pool.
Employer plan balances, such as many 401(k) accounts, are not the same as IRA balances for this specific calculation, but rollovers between plans and IRAs can change the picture.
Records That Matter
Good Form 8606 records are essential. Without basis tracking, a taxpayer may pay tax twice on after-tax IRA contributions or misunderstand how much of a conversion is taxable.
Example
Suppose a taxpayer has $95,000 of pretax IRA money and $5,000 of after-tax basis, for a total IRA value of $100,000. If the taxpayer converts $10,000 to a Roth IRA, only 5% of the conversion is treated as nontaxable basis. The remaining 95% is generally taxable, even if the taxpayer intended to convert only the after-tax contribution.
This is why the rule is often discussed before a backdoor Roth IRA contribution, not after the conversion has already been made.
The Bottom Line
The pro-rata rule prevents cherry-picking only after-tax IRA dollars for distribution or Roth conversion. It makes IRA basis tracking and account aggregation central to nondeductible IRA and backdoor Roth planning.