What is the IRS Pro-Rata Rule?
Under Internal Revenue Code §408(d)(2), the IRS does not allow you to convert only your after-tax (non-deductible) dollars during a Backdoor Roth IRA conversion. Instead, the IRS views all of your Traditional, Rollover, SEP, and SIMPLE IRAs across all brokerages as one single combined account on December 31 of the conversion year.
The Pro-Rata Math Example
Suppose you have $93,000 of pre-tax funds in an old Rollover IRA and contribute $7,000 in new non-deductible cash for a Backdoor Roth conversion:
- Total IRA pool = $100,000 ($93,000 pre-tax + $7,000 after-tax).
- Only 7% ($7,000 / $100,000) of your $7,000 conversion is tax-free; 93% ($6,510) will be taxed as ordinary income!
How to Avoid the Pro-Rata Trap
Before December 31 of the year you execute a Backdoor Roth conversion, perform a reverse rollover of your pre-tax IRA balances into your current employer's 401(k) (or Solo 401(k)), reducing your pre-tax IRA balance to $0 on Form 8606 Line 6.