How Bad Is the Pro Rata Rule, Really?
Read to the end for a special trivia question!
Should you pay a lot of tax once or a little bit of tax, year after year? The answer depends on your timing and tax rate.
The pro rata rule is often described as the “death blow” to the backdoor Roth IRA. In reality, it’s not nearly as bad as many physicians assume. In some cases, it simply forces you to think more strategically about timing and tax brackets.
Let’s break it down.
Part I – What Is the Pro Rata Rule?
The pro rata rule prevents taxpayers from converting only their after-tax IRA contributions while ignoring pre-tax balances. When you convert funds from a traditional IRA to a Roth IRA, the IRS looks at all Traditional, SEP, and SIMPLE IRAs you own, aggregated.
This calculation is reported on Form 8606.
Example
A physician:
Contributes $7,500 as a nondeductible IRA contribution
Has $100,000 of pre-tax IRA funds
Total IRA balance: $107,500
The after-tax portion is:
7,500 ÷ 107,500 ≈ 7.0%
If the physician converts $7,500, only about 7% (~$525) is tax-free.
The remaining ~$6,975 is taxable ordinary income.
That’s the pro rata rule in action.
Part II – How to Avoid the Pro Rata Rule
There are two main ways to eliminate pre-tax IRA balances before doing a backdoor Roth.
1. Roll Pre-Tax IRA Funds Into a Qualified Plan
Examples include:
Employer 401(k)
Solo 401(k)
403(b) plans
Once the pre-tax funds are rolled out of the IRA, the IRA contains only after-tax basis, allowing clean backdoor Roth conversions. Note - there are situations where you can’t just move money out (for instance, you may have contributed to a SIMPLE IRA in the first two years.
Pros
No tax triggered
Preserves tax-deferred growth
Allows full backdoor Roth strategy
Cons
Requires a plan that accepts rollovers
Investment options may be limited
Fees may be higher depending on the plan
Solo 401(k) Option for Side Businesses
Many physicians overlook this:
If you have any legitimate side business income, you can open a solo 401(k) and roll pre-tax IRA balances into it.
Important point:
Rollovers are not limited by contribution limits.
You can move large IRA balances regardless of annual limits.
This is often the cleanest solution for independent contractors, locums physicians, or anyone with 1099 income.
2. Convert Pre-Tax IRA Funds to Roth
You can also eliminate the problem by converting pre-tax IRA funds and paying the tax.
Pros
Simplifies accounts
Creates tax-free growth going forward
No future RMDs on Roth assets
Cons
Immediate tax bill
May push you into a higher bracket
Timing conversions in lower-income years is often key.
Part III – What If You Can’t Avoid the Pro Rata Rule?
If you can’t roll funds out or convert everything now, the pro rata rule essentially turns your IRA into a forced partial Roth conversion.
At that point, the decision becomes a tax-rate comparison problem.
Ask:
What is my marginal tax rate now?
What do I expect it to be in retirement?
Will I have lower-income years available for conversions?
Comparing IRA vs Taxable Account
Suppose two physicians:
Are in the 37% bracket today*
Have $100,000 pre-tax IRA balances
Want to save $7,500
Plan to retire in 35 years
Expect a 24% tax bracket in retirement*
Assume 8% annual return
Taxes on IRA withdrawals and conversions are paid with cash flow or assets in non-retirement accounts.
Taxable account has 0.3% annual tax drag (15% tax on qualified dividends, 2% dividend yield per year)
* - Marginal tax rate is rarely this simple. For more, read my prior post on the many variables that can increase marginal tax rate.
Taxable Account Scenario
After 35 years:
Account value ≈ $99,800
Basis: $7,500
Capital gain ≈ $92,000
LTCG tax (15%) ≈ $13,800
After-tax total ≈ $85,700
Nondeductible IRA Scenario
If growth is taxed at 24% on withdrawal:
Value grows to ≈ $111,000
Gain ≈ $103,500
Tax ≈ $25,000
After-tax total ≈ $86,000
Virtually identical to the taxable account outcome.
What If Your Tax Bracket Drops Earlier?
If your income drops in 10 years instead of 35, you can convert earlier at lower rates.
This means:
Less time for gains to accumulate before conversion
Less tax paid
Better after-tax outcome than taxable investing
This is common for physicians who:
Reduce clinical hours
Transition to part-time or telehealth
Retire early
Sell a practice
In this scenario, your $7,500 contribution grows to about $16k over 10 years. Compared to the original non-deductible IRA scenario (where you withdraw after 35 years), the gains and the tax liability from the conversion is greatly diminished.
Important Caveats
Taxable accounts have real advantages:
Withdraw anytime (no age 59½ rule)
No RMDs
Step-up in basis at death
More flexibility for large purchases
This is not a blanket statement that IRAs are superior to taxable accounts. The optimal strategy depends on your specific situation.
Consult a qualified professional before making decisions.
TaxSmart Takeaway
Don’t be afraid of the pro rata rule—be strategic about Roth conversion timing.
Even if the rule applies, outcomes may be similar to taxable investing over long periods.
If you expect lower tax brackets in the future, partial Roth conversions during down years can significantly improve after-tax wealth.
For physicians planning to spend down their assets in retirement, paying ordinary income tax on conversions may sometimes beat long-term tax drag in taxable accounts.
Special Trivia Question!
Most IRA accounts are factored into the pro rata rule. Which are not (more than one answer may be correct)?
A. Rollover IRA
B. SIMPLE IRA
C. Roth IRA
D. SEP IRA
E. Inherited IRA
Click here for the answer!