Pro-Rata Rule
The pro-rata rule (IRC §408(d)(2)) requires that all of a taxpayer's traditional, SEP, and SIMPLE IRAs be aggregated when calculating the taxable portion of any distribution or Roth conversion. The taxable percentage equals (pre-tax balance) ÷ (total IRA balance), and applies regardless of which specific IRA the conversion comes from.
The rule exists to prevent taxpayers from selectively converting only the after-tax portion of their IRAs and avoiding tax on the pre-tax portion. In practice it most painfully traps the 'backdoor Roth' strategy: high-income taxpayers contribute non-deductible (after-tax) dollars to a traditional IRA, then convert immediately to a Roth. With no pre-tax IRA balance, the conversion is essentially tax-free; with pre-tax balance, the conversion becomes pro-rata taxable.
The aggregation includes traditional, SEP, and SIMPLE IRAs across all custodians and all rollover sources. A taxpayer with $100k of pre-tax rollover IRA from an old 401(k) and a $7k after-tax non-deductible contribution attempting a backdoor Roth will be taxed on $100k / $107k = 93.5% of the $7k conversion, or roughly $6.5k taxable. The strategy still works mechanically but the tax cost obliterates the benefit.
The canonical workaround is to roll pre-tax IRA balances into the taxpayer's current 401(k) before doing the backdoor — 401(k)s are NOT included in the IRA aggregation. After the rollover, the only IRA balance is the after-tax contribution, and the conversion is fully tax-free. Not all 401(k) plans accept rollovers, and the rollover itself can have plan-specific quirks, but where it works it cleanly resolves the pro-rata problem.
The rule applies on December 31 of the conversion year. A taxpayer who rolls pre-tax IRAs into a 401(k) on December 30 and does the conversion on December 31 has a clean year-end snapshot and a tax-free conversion — timing matters.
T = (pre_tax / total_IRA) × C- T
- = taxable amount of the conversion
- pre_tax
- = December 31 pre-tax IRA balance (across all traditional/SEP/SIMPLE)
- total_IRA
- = December 31 total IRA balance (pre-tax + after-tax)
- C
- = conversion amount
pre_tax=$93,000, total_IRA=$100,000, C=$7,000. T = (93,000/100,000) × 7,000 = $6,510 taxable on what was supposed to be a tax-free backdoor conversion.Synthetic households doing backdoor Roth strategy testing need realistic pre-tax IRA balances on members, including rollover IRA balances that originated from old employer plans. The 'clean' household (zero pre-tax IRA, can backdoor freely) and the 'trapped' household (significant pre-tax IRA, backdoor is costly) are both important test scenarios; engines that only model one path miss half the user base.
Common pitfalls
- Computing pro-rata on the conversion-year contribution amount instead of the December 31 IRA total — gives the wrong tax answer.
- Aggregating Roth IRA balances into the calculation — Roth IRAs are NOT in the §408(d)(2) aggregation.
- Forgetting that a 401(k)-to-IRA rollover on the same year as a planned backdoor will pollute the IRA balance and trigger pro-rata. Sequencing matters.
- Assuming inherited IRAs aggregate with the taxpayer's own — inherited IRAs are tracked separately for pro-rata purposes.
Examples
Taxpayer has $93k pre-tax rollover IRA + $7k of just-contributed non-deductible after-tax. Total IRA = $100k. Pro-rata: 93% pre-tax. The $7k Roth conversion is 93% taxable = $6,510 of ordinary income on a $7k 'tax-free' move. Effective tax cost ~24%.
Same taxpayer rolls the $93k pre-tax IRA into their current employer's 401(k) on December 30. December 31 IRA balance: $7k of after-tax. Conversion the next day is 0% pre-tax = fully tax-free.