There is an answer to a similar question in the community, but this situation is a little bit different.
There is an IRRA account that was a rollover from a retirement plan and has been sitting for a few years, worth about $1500. In 2024 a non-deductible contribution to an IRA of $3000 was made. The $3000 are then converted to roth IRA from the IRA.
1) How is the prorate rule works here? Since the non-deductible contributions are more than pre-tax IRRA funds. How is this calculation done?
2) For 2025, if non-deductible contributions are made (say, worth $2000), and then converted to roth, is the prorata rule applicable here again? In other words, it sounds as if the IRRA funs will be taxed every year there is a non-deductible contribution to an IRA that gets converted to a roth IRA. If so, is it advisable to convert the IRRA funds before converting the non-deductible IRA funds?
Thank you!
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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.
I don't know what an IRRA account is, what do you mean?
Assuming you mean it was a traditional IRA with a pre-tax balance, then all traditional IRAs are considered for the pro rata rule.
If you had $1500 of pre-tax funds, contributed $3000 of non-deductible funds, and converted $3000 to a Roth IRA, then 66% of the converted amount is after-tax and 33% is pre-tax, so you will pay income tax on $1000 of the conversion. That leaves you with a balance of $1500, of which $500 is still pre-tax and $1000 is after tax (has a basis). This is all recorded on the form 8606 that is generated with your tax return.
Thank you very much for the detailed answer!
Yes, it makes a lot of sense like you said to "rollover the entire account balance for 2025." This actually is part of the confusion.
Following up on this "After the rollover, the $1,500 remaining balance will be made up of $500 deductible contributions and $1,000 nondeductible contributions.", where is this tracked for 2025 taxes? The actual funds (the original $1,500 pre-tax) will continue to be $1500 (+/- gains) on the bank statement (the year-end statement/Dec 2025 statement).
Another follow up, say we do "rollover the entire account balance..." and the $2000 non-d contributions, wouldn't form 1099-R show a total of $3500 amount. Only $500 should be taxed in this case (because the $1000 was taxed already). Or how does that scenario works?
Thank you very much!
@Opus 17 , thank you for your reply, and IRRA is just a type of IRA account (a rollover IRA-account)
@Novahut wrote:
Thank you very much for the detailed answer!
Yes, it makes a lot of sense like you said to "rollover the entire account balance for 2025." This actually is part of the confusion.
Following up on this "After the rollover, the $1,500 remaining balance will be made up of $500 deductible contributions and $1,000 nondeductible contributions.", where is this tracked for 2025 taxes? The actual funds (the original $1,500 pre-tax) will continue to be $1500 (+/- gains) on the bank statement (the year-end statement/Dec 2025 statement).
Another follow up, say we do "rollover the entire account balance..." and the $2000 non-d contributions, wouldn't form 1099-R show a total of $3500 amount. Only $500 should be taxed in this case (because the $1000 was taxed already). Or how does that scenario works?
Thank you very much!
@Opus 17 , thank you for your reply, and IRRA is just a type of IRA account (a rollover IRA-account)
IRRA is not a recognized term anywhere that I know of or can find. A rollover IRA is identical to an IRA for all tax purposes. If you have a traditional IRA, it doesn't matter how it was funded (contributions, or rollover from a previous plan), they are all considered "individual retirement arrangements".
The non-deductible basis of your IRA and your Roth conversions are tracked on form 8606. Your 2024 return will have a form 8606 showing the non-deductible contribution, the partial conversion, the calculation of the taxable amount, and the remaining non-deductible basis left in the traditional IRA.
If you do another Roth IRA conversion in 2025, you will use information from the 2024 form 8606 to prepare your 2025 tax return including a new form 8606 that documents the basis in your IRA, the conversion, and the calculation of the taxable amount.
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