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The Pro-Rata Rule and Backdoor Roth Conversions

 For tax purposes, the IRS considers all your (seemingly separate) IRAs as one big account. The pro-rata rule boils down to the percentage of your total combined IRA balances that has yet to be taxed. Whatever that percentage is determines the percentage of your backdoor Roth IRA conversion that will be taxed.

For example, let’s say you have $94,000 in existing traditional IRAs that were funded with pre-tax dollars. And now you contribute $6,000 to a new traditional IRA with after-tax dollars, then immediately convert that $6,000 to a Roth via the backdoor Roth IRA strategy.

As far as the IRS is concerned, you now have $100,000 in traditional IRAs, and the $6,000 you are contributing with after-tax dollars represents 6% of your total. That means only $360 of your $6,000 backdoor conversion is tax-free (6% of $6,000). You owe income tax on the other $5,640 you backdoored.

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