KeshaH
Expert Alumni

Retirement tax questions

The pro rata rule means that if there are deductible (or pre-tax) and nondeductible (or after tax) contributions in a qualified retirement account, a partial rollover into a Roth account will be partially taxable and partially tax-free. The taxable portion will be calculated based on the value of the deductible contributions to the value of the full account.

 

In your example: $1,500/$4,500 = 1/3 of your rollover should be taxable. You'll include $1,000 in income on a $3,000 rollover. 

 

After the rollover, the $1,500 remaining balance will be made up of $500 deductible contributions and $1,000 nondeductible contributions. When you contribute $2,000 in nondeductible contributions, your balance will then be $500 deductible contributions and $3,000 in nondeductible contributions for a total of $3,500.

 

If you then rollover $2,000 to a Roth account, you'd have about $286 in taxable distribution ($500/$3,500 multiplied by the $2,000).

 

The best way to avoid the pro rata rule is to rollover the entire account balance for 2025. You'd have a taxable distribution of $500 in 2025 but any future rollovers would be completely tax free assuming there are no more deductible contributions made to the account.