IRA Pro Rata Rule Calculator
What is the IRA Pro Rata Rule?
The IRS Pro Rata rule determines the taxation of withdrawals or Roth conversions when an individual holds both pre-tax and after-tax (non-deductible) funds in their Traditional IRA accounts. Since the IRS views all your Traditional, SEP, and SIMPLE IRAs as one single entity, you cannot choose to convert only the "after-tax" dollars. Instead, any conversion or withdrawal must be taken proportionally from both pools of money.
The Aggregation Rule
A common mistake in the "Backdoor Roth" strategy is assuming that if you open a new Traditional IRA and deposit $6,000 of non-deductible money, you can convert just that account tax-free. However, if you have $94,000 in a separate SEP IRA, the IRS considers your total IRA balance to be $100,000. In this case, only 6% of your conversion would be tax-free.
How the Calculation Works
The math follows a specific formula defined by IRS Form 8606:
- Step 1: Total Non-Deductible Basis / Total Balance of all IRAs = Tax-Free Ratio.
- Step 2: Tax-Free Ratio * Conversion Amount = Non-Taxable Portion.
- Step 3: Conversion Amount – Non-Taxable Portion = Taxable Portion.
Example Scenario
Suppose you have $10,000 in non-deductible contributions (basis) and your total balance across all Traditional IRAs is $50,000. You decide to convert $10,000 to a Roth IRA.
Your ratio is $10,000 / $50,000 = 0.20 (or 20%). When you convert $10,000, only $2,000 (20%) is tax-free, while $8,000 (80%) is added to your taxable income for the year.
Important Considerations
The "Total Value" used in the denominator is calculated based on the balance of your accounts on December 31st of the year the conversion takes place. This means that investment gains or additional contributions throughout the year can change your final tax liability. To avoid the Pro Rata rule, many taxpayers look into "Reverse Rollovers," where pre-tax IRA funds are moved into a 401(k) plan, as employer-sponsored plans are generally excluded from the Pro Rata calculation.