Mixing Pre-and After-Tax 401(k) Dollars? Beware the Pro Rata Rule Tax Hit

by Prof. Robert Bloink and Prof. William H. Byrnes

As clients amass their retirement dollars over their working years, tax situations are likely to become more complicated over time. That’s especially true for clients who are fortunate enough to have the means to contribute after-tax dollars above and beyond the annual pre-tax deductible 401(k) contribution limit. As time passes and clients wish to move those retirement dollars between accounts, it’s particularly important to understand the rules governing after-tax retirement contributions—which are different from the rules governing Roth funds. One rule that can become particularly complex (and often surprises clients) is the so-called pro-rata rule, which applies in cases where a client has contributed non-Roth after-tax funds to a traditional 401(k) and later wishes to roll over (or convert) those funds.

Pro-Rata Rule Basics