Pro-rata rule

The rule matters most for a backdoor Roth, where you convert a traditional IRA contribution you did not deduct. After-tax money in an IRA is your basis, and it comes out tax-free. The tax-free part of each dollar you withdraw or convert is your basis divided by the total in all your IRAs. Section 408(d)(2) of the tax code sets out this rule, and you work it out on Form 8606.

The total uses your IRA balances on December 31 of the year you convert, plus what you took out that year. Say you make a $7,500 nondeductible contribution, the 2026 limit under age 50, and convert it in February. If a rollover IRA holds $92,500 of pre-tax money on December 31, only 7.5% of the conversion is tax-free. That 7.5% is $7,500 of basis divided by $100,000: the $92,500 in the rollover IRA plus the $7,500 you converted. You owe tax on $6,937.50 of the $7,500, and the unused basis carries forward to later years.

The usual fix is to roll all pre-tax IRA money into your 401(k) by December 31, if the plan accepts it. The rule leaves out 401(k)s, 403(b)s and other workplace plans that are not IRAs. Once the pre-tax IRA money is gone, only the conversion’s earnings stay taxable. Roth IRAs and IRAs you inherited stay out of the count too.