Nondeductible IRAs and the Pro-Rata “Income-Splitting” Rule
Guidance from Your Trusted CPA Advisors
For high-income earners, retirement planning often requires navigating rules that limit or phase out certain tax benefits. One common challenge is the inability to deduct traditional IRA contributions or contribute directly to a Roth IRA once income exceeds IRS thresholds. In these cases, a nondeductible IRA can be a strategic alternative—if managed correctly.
What Is a Nondeductible IRA?
A nondeductible IRA allows you to make after-tax contributions to a traditional IRA. While you don’t receive an upfront tax deduction, your investments still benefit from tax-deferred growth. In many situations, nondeductible IRAs serve as a foundation for the backdoor Roth strategy, a popular tool for high-income households seeking tax-free retirement growth.
The Critical Rule: The Pro-Rata “Income-Splitting” Requirement
Before making nondeductible contributions or pursuing a backdoor Roth conversion, it’s essential to understand the IRS pro-rata rule—often referred to as the income-splitting rule. This rule prevents taxpayers from selectively converting only their after-tax contributions.
Here’s how it works:
The IRS looks at the total value of all your traditional IRAs, including SEP and SIMPLE IRAs—not just the account receiving the nondeductible contribution.
You must calculate the percentage of your overall IRA balance that consists of nondeductible (after-tax) contributions.
Any withdrawal or Roth conversion must include the same percentage of after-tax and pre-tax dollars.
For example, if only 15% of your aggregated IRA balance represents nondeductible contributions, then only 15% of a Roth conversion will be tax-free. The remaining 85% will be taxed as ordinary income.
Why This Matters for Your Strategy
The pro-rata rule can significantly affect the tax outcome of a backdoor Roth conversion. Clients with large pre-tax IRA balances may face unexpected tax bills if they convert without proper planning. In many cases, rolling pre-tax IRA funds into an employer-sponsored 401(k)—when permitted—can help isolate after-tax dollars and improve tax efficiency.
How Our Firm Helps
Our CPA team works closely with clients to evaluate their full retirement landscape, model the tax impact of nondeductible IRA strategies, and coordinate conversions to optimize long-term tax savings.
We provide:
Pro-rata rule calculations and tax projections
Guidance on timing and structuring conversions
Coordination with employer plans to minimize tax exposure
Comprehensive retirement and tax-planning strategies tailored to your goals
If you’re considering a nondeductible IRA or backdoor Roth strategy, proper planning is essential. Contact our firm to ensure your retirement strategy is compliant, tax-efficient, and aligned with your long-term financial goals.
