The Pro-Rata Rule is perhaps the most misunderstood aspect of IRA management. To understand it, you must first understand the IRA Aggregation Rule. The IRS dictates that for the purposes of taxation, all of an individual's Traditional IRAs, SEP IRAs, and SIMPLE IRAs are treated as one single account . It does not matter if you have one IRA at Vanguard, one at Fidelity, and another at a local bank; in the eyes of the IRS, you have one giant pool of money .

The "Cream in Coffee" Analogy

Imagine you have a cup of coffee representing your pre-tax IRA assets (money that has never been taxed). Now, imagine you pour a small amount of cream into that coffee, representing your nondeductible (after-tax) contribution. Once you stir that cream into the coffee, you cannot reach into the cup with a spoon and pull out only the cream. Any spoonful you take out will be a mixture of coffee and cream in the exact same proportion as the whole cup.

The Pro-Rata Rule works exactly like that spoonful. If 90% of your total IRA assets are pre-tax (the coffee) and 10% are after-tax (the cream), then 90% of any conversion or distribution you take will be taxable, regardless of which specific account you "pull" the money from .

Calculating the Taxable Percentage

The formula for the Pro-Rata Rule is a simple ratio, but its implications are profound. To find the tax-free portion of your conversion, you divide your total "basis" (after-tax contributions) by the total value of all your non-Roth IRAs .

The Formula:
(Total Nondeductible Basis) / (Total Value of ALL Traditional, SEP, and SIMPLE IRAs) = Tax-Free %

Case Study: The Rollover Trap

Consider Sarah, a high-earning executive. Sarah has $93,000 in a Rollover IRA from a previous job's 401(k). This money is entirely pre-tax. In 2026, Sarah decides to do a Backdoor Roth IRA. She opens a new, empty Traditional IRA and contributes $7,500 as a nondeductible contribution . She now has $100,500 in total IRA assets.

Sarah thinks she can just convert the "new" $7,500 to a Roth IRA tax-free because she already paid taxes on that specific $7,500. However, the Pro-Rata Rule applies:

Total Basis: $7,500
Total IRA Assets: $100,500 ($93,000 + $7,500)
Tax-Free Ratio: $7,500 / $100,500 = ~7.46%
Taxable Ratio: ~92.54%

When Sarah converts $7,500, only about $560 is tax-free. The remaining $6,940 is added to her taxable income for the year . If Sarah is in the 37% tax bracket, this "simple" conversion just cost her over $2,500 in unexpected federal taxes.

Common Accounts Subject to Aggregation

Many investors mistakenly believe that certain types of IRAs are exempt from this rule. The IRS is very specific about what counts toward your "total IRA balance" on December 31st of the year you do a conversion :

Traditional IRAs: Both deductible and nondeductible.
Rollover IRAs: Often containing large pre-tax sums from former employers.
SEP IRAs: Simplified Employee Pension plans for the self-employed.
SIMPLE IRAs: Savings Incentive Match Plan for Employees.

What is NOT included:

Roth IRAs: These are already after-tax and do not affect the calculation .
Inherited IRAs: These are treated as separate entities and do not aggregate with your own IRAs .
401(k), 403(b), and 457(b) Plans: Employer-sponsored qualified plans are the "safe harbor" for pre-tax money .

The December 31st Rule

A crucial detail often missed is that the Pro-Rata calculation is based on your total IRA balances as of December 31st of the year the conversion occurs . This means you cannot "hide" money by moving it around mid-year. If you have a large IRA balance on New Year's Eve, it will trigger the Pro-Rata Rule for any conversion you did earlier that year. This "snapshot" approach by the IRS makes year-end planning vital.

Frequently Asked Questions: Pro-Rata Rule

Can I just open an IRA at a different bank to avoid this?
No. The IRS Aggregation Rule ignores where the accounts are held. It treats you as one taxpayer with one pool of IRA money .
Does the rule apply if I only convert the "new" money?
Yes. The IRS does not allow "cherry-picking." Every dollar converted is assumed to be a proportional mix of pre-tax and after-tax funds .
What if my IRA lost money?
The calculation is based on the fair market value of the accounts at the time of conversion and at year-end. If the total value drops, your basis (the dollar amount you contributed) stays the same, which actually increases your tax-free percentage.
Is the Pro-Rata Rule the same as the 5-year rule?
No. The Pro-Rata Rule determines how much of your conversion is taxed today. The 5-year rule determines when you can withdraw those funds and their earnings tax-free in the future .