Pro-Rata Rule for Backdoor Roth IRA Conversions

The pro-rata rule plays a critical role for individuals using the backdoor Roth IRA strategy, which involves making a non-deductible (after-tax) contribution to a traditional IRA and then converting those funds to a Roth IRA. While the backdoor Roth IRA is a popular way to bypass income limits on direct Roth contributions, the IRS requires that all traditional IRA accounts — including SEP and SIMPLE IRAs — be aggregated when calculating the taxable amount of any conversion. This means the conversion is not solely tax-free based on the after-tax contribution but is determined by the ratio of your total pre-tax IRA funds to after-tax basis.

Think of your IRA funds as a single “pot” mixing after-tax money (on which you’ve already paid taxes) and pre-tax money (tax deferred). The IRS formula applies the pro-rata rule to ensure you pay tax on the pre-tax share of any traditional IRA amounts converted to a Roth IRA.

How the Pro-Rata Rule Works

1. Determine Total IRA Balances: Add together the balances of all your traditional, SEP, and SIMPLE IRAs as of December 31 of the conversion year. This total includes both the pre-tax funds (deductible contributions and earnings) and after-tax basis (non-deductible contributions).

2. Calculate After-Tax Basis: Identify the amount of after-tax contributions you have in these IRAs, often documented on IRS Form 8606.

3. Apply the Pro-Rata Formula:

[
\text{Non-taxable portion} = \text{Conversion Amount} \times \frac{\text{After-tax basis}}{\text{Total IRA balance}}
]

The remaining portion of your converted funds is taxable income and will be included in your gross income for the tax year.

Example

Suppose you contribute $6,500 in non-deductible funds to a traditional IRA and then convert $6,500 to a Roth IRA. However, you have $24,000 in other traditional IRAs containing pre-tax funds.

• Total IRA balance = $6,500 (after-tax) + $24,000 (pre-tax) = $30,500
• After-tax basis = $6,500
• Non-taxable portion = $6,500 × ($6,500 ÷ $30,500) ≈ $1,385
• Taxable portion = $6,500 – $1,385 = $5,115 (taxable as income)

Without the pro-rata rule, the entire conversion might seem tax-free, but because of pre-tax balances, a significant portion is subject to income tax.

Who Should Be Concerned

The pro-rata rule primarily affects those who have any pre-tax funds in their traditional, SEP, or SIMPLE IRAs and want to execute backdoor Roth IRA conversions. If you only have after-tax contributions and no other IRA balances, the entire conversion can usually be tax-free.

Strategies to Reduce Tax Impact

• Roll Over Pre-Tax IRAs into a 401(k): Many employer plans accept IRA rollovers. Moving pre-tax IRA funds into your 401(k) reduces your IRA balances, which lowers the pre-tax proportion in your IRAs and reduces taxable amounts during conversion.
• Perform Conversions When IRA Balances Are Minimal: Convert after-tax contributions when you have no or minimal pre-tax IRA balances.
• Maintain Accurate Record-Keeping: File Form 8606 each year to track your after-tax basis accurately.

Common Misunderstandings

• The entire backdoor Roth IRA conversion is not automatically tax-free if you have other pre-tax IRA money.
• The pro-rata rule applies regardless of conversion size, allocating tax proportionally.
• You cannot selectively convert only after-tax IRA contributions without tax implications; the IRS views all IRAs as one combined account.

Additional Guidance and Reporting

You must report non-deductible contributions and conversions on IRS Form 8606 to avoid double taxation. The pro-rata rule does not apply to Roth IRAs or Roth 401(k)s, only traditional, SEP, and SIMPLE IRA balances.

Since the 2018 tax law changes, recharacterizing (reversing) a Roth conversion is no longer allowed. Therefore, planning carefully before conversion is essential.

For more on the backdoor Roth IRA, see our detailed Backdoor Roth IRA guide. Learn about Nondeductible IRA Contribution and Roth Conversion basics to deepen your understanding. If you have pre-tax IRA funds, consider options like a 401(k) Rollover to manage tax exposure.

Sources

• IRS Form 8606 Instructions: https://www.irs.gov/forms-pubs/about-form-8606
• IRS Topic No. 557 – Roth IRAs: https://www.irs.gov/taxtopics/tc557
• NerdWallet, “Backdoor Roth IRA and Pro-Rata Rule”: https://www.nerdwallet.com/article/investing/backdoor-roth-ira
• Investopedia, “The Pro-Rata Rule and Backdoor Roth IRA”: https://www.investopedia.com/articles/retirement/08/backdoor-roth.asp

Understanding the pro-rata rule helps you navigate backdoor Roth IRA conversions confidently and avoid costly surprise taxes. Proper planning and record-keeping are essential steps toward smart retirement tax strategies.