Tax Facts
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
While the situation may eventually become less common now that Roth 401(k)s are becoming more mainstream, many clients have had the opportunity to contribute after-tax dollars to their employer-sponsored 401(k)s. Most often, a client may make after-tax contributions when they have already maxed out their pre-tax 401(k) contributions (so, for example, they wish to contribute more than the $23,500 pre-tax limit in 2025). Not all plans allow for after-tax contributions, so (as always) it’s important to examine the specific plan terms.
When a 401(k) account contains both pre-tax and after-tax amounts, the owner can’t simply later move the after-tax dollars to a Roth IRA (or, on the other hand, simply move the pre-tax dollars to a traditional IRA and leave the after-tax dollars alone). Any distribution from the account must contain both pre-tax and after-tax dollars. Each distribution will contain a proportionate share of each type of contribution.
For example, assume a client’s account balance is $100,000, $80,000 of which were pre-tax contributions (80%) and $20,000 were after-tax contributions (20% of the overall balance). A $50,000 distribution would consist of $40,000 in pre-tax dollars and $10,000 in after-tax amounts.
The client can’t simply withdraw the after-tax funds in a non-taxable transaction. If any pre-tax dollars are in the account, at least some tax liability will be triggered on distribution.
It’s also important to understand that earnings on after-tax dollars are treated as pre-tax amounts. The IRS clearly distinguishes these funds from Roth account funds, where the earnings on contributions can be withdrawn tax-free. In other words, while actual after-tax contributions to a 401(k) won’t be taxable on distribution (they’ve already been taxed), the earnings associated with those contributions are taxable income when distributed.
Rollovers and Conversions
Many clients may remember an IRS ruling back in 2014 that allowed taxpayers to send pre-tax amounts and after-tax amounts to different receiving accounts in a rollover (assuming the different types of contributions were properly tracked within the plan). That’s still the case—but the pro rata rule continues to apply.
Considering the example above, the client can rollover the $10,000 in after-tax amounts to a Roth IRA and the $40,000 in pre-tax amounts to a traditional IRA. Earnings on the after-tax amounts would be rolled over into the traditional IRA (because earnings on after-tax contributions are treated as pre-tax amounts).
Moving after-tax 401(k) contributions to a Roth account can be extremely valuable, given the potential to generate tax-free earnings within the Roth vehicle. It’s important to remember, however, based on these rules, to roll over all of a client’s after-tax contributions to a Roth IRA, the client would have to deplete the entire account (either by rolling over the pre-tax amounts into a traditional IRA or taking the pre-tax amounts as a taxable distribution).
The pro-rata rule is also important when it comes to calculating the tax liability on a “backdoor” Roth conversion. If the account contains pre-tax and after-tax amounts, the Roth conversion is taxed in proportion to the pre- and post-tax percentages in the account.
When it comes to moving 401(k) dollars, clients should be advised that any given 401(k) plan may have its own set of rules when it comes to withdrawing plan assets (especially when it comes to hardship distributions). The plan terms may require the participant to withdraw pre-tax dollars before any Roth dollars can be withdrawn. This can also make separating the funds between a Roth and traditional IRA more attractive—by giving the participant greater control over how they access their retirement savings.
Conclusion
The presence of after-tax 401(k) contributions can complicate a client’s tax picture—often in ways that are surprising to clients who may have (understandably) equated “after-tax” with “Roth”. Understanding the pro-rata rule for separating those funds can help clients maximize the value of their overall retirement funding without creating tax headaches.
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
While the situation may eventually become less common now that Roth 401(k)s are becoming more mainstream, many clients have had the opportunity to contribute after-tax dollars to their employer-sponsored 401(k)s. Most often, a client may make after-tax contributions when they have already maxed out their pre-tax 401(k) contributions (so, for example, they wish to contribute more than the $23,500 pre-tax limit in 2025). Not all plans allow for after-tax contributions, so (as always) it’s important to examine the specific plan terms.
When a 401(k) account contains both pre-tax and after-tax amounts, the owner can’t simply later move the after-tax dollars to a Roth IRA (or, on the other hand, simply move the pre-tax dollars to a traditional IRA and leave the after-tax dollars alone). Any distribution from the account must contain both pre-tax and after-tax dollars. Each distribution will contain a proportionate share of each type of contribution.
For example, assume a client’s account balance is $100,000, $80,000 of which were pre-tax contributions (80%) and $20,000 were after-tax contributions (20% of the overall balance). A $50,000 distribution would consist of $40,000 in pre-tax dollars and $10,000 in after-tax amounts.
The client can’t simply withdraw the after-tax funds in a non-taxable transaction. If any pre-tax dollars are in the account, at least some tax liability will be triggered on distribution.
It’s also important to understand that earnings on after-tax dollars are treated as pre-tax amounts. The IRS clearly distinguishes these funds from Roth account funds, where the earnings on contributions can be withdrawn tax-free. In other words, while actual after-tax contributions to a 401(k) won’t be taxable on distribution (they’ve already been taxed), the earnings associated with those contributions are taxable income when distributed.
Rollovers and Conversions
Many clients may remember an IRS ruling back in 2014 that allowed taxpayers to send pre-tax amounts and after-tax amounts to different receiving accounts in a rollover (assuming the different types of contributions were properly tracked within the plan). That’s still the case—but the pro rata rule continues to apply.
Considering the example above, the client can rollover the $10,000 in after-tax amounts to a Roth IRA and the $40,000 in pre-tax amounts to a traditional IRA. Earnings on the after-tax amounts would be rolled over into the traditional IRA (because earnings on after-tax contributions are treated as pre-tax amounts).
Moving after-tax 401(k) contributions to a Roth account can be extremely valuable, given the potential to generate tax-free earnings within the Roth vehicle. It’s important to remember, however, based on these rules, to roll over all of a client’s after-tax contributions to a Roth IRA, the client would have to deplete the entire account (either by rolling over the pre-tax amounts into a traditional IRA or taking the pre-tax amounts as a taxable distribution).
The pro-rata rule is also important when it comes to calculating the tax liability on a “backdoor” Roth conversion. If the account contains pre-tax and after-tax amounts, the Roth conversion is taxed in proportion to the pre- and post-tax percentages in the account.
When it comes to moving 401(k) dollars, clients should be advised that any given 401(k) plan may have its own set of rules when it comes to withdrawing plan assets (especially when it comes to hardship distributions). The plan terms may require the participant to withdraw pre-tax dollars before any Roth dollars can be withdrawn. This can also make separating the funds between a Roth and traditional IRA more attractive—by giving the participant greater control over how they access their retirement savings.
Conclusion
The presence of after-tax 401(k) contributions can complicate a client’s tax picture—often in ways that are surprising to clients who may have (understandably) equated “after-tax” with “Roth”. Understanding the pro-rata rule for separating those funds can help clients maximize the value of their overall retirement funding without creating tax headaches.
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