Let's say you have $5,000 in a deductible traditional IRA. You want to contribute $5,000 to a backdoor Roth IRA so you open a non-deductible traditional IRA and fund it with $5,000 to convert to a Roth IRA.
According to the pro-rata rule, you have a total IRA balance of $10,000 with a 50/50 split between pre-tax and post-tax money. As such, you must pay taxes on 50% of the converted amount i.e. $2,500 in this example.
What isn't clear to me is what happens to the post-tax and pre-tax balances after this conversion takes place. On the one hand, you have now paid taxes on $2,500 of the pre-tax money, so it seems to me that that portion of the distribution is coming from the pre-tax IRA in order to maintain the existing proportion of post-tax vs. pre-tax funds. On the other hand, you are doing a conversion of the post-tax IRA, so it seems to me that the full amount is coming from the post-tax IRA.
Would the post-conversion balances look like 'A' or 'B'?
A. Funds are distributed only from the post-tax balance being converted:
- Deductible IRA: $5000
- Non-Deductible IRA: $0
- Roth IRA: $5000
B. Funds are distributed such that pre-tax/post-tax balances remain proportional:
- Deductible IRA: $2500
- Non-Deductible IRA: $2500
- Roth IRA: $5000
Case 'A' seems like it would result in double taxation -- you are paying taxes on $2,500 of the already post-tax funds for the conversion and still owe taxes on the $2,500 from the pre-tax IRA that applied to the pro-rata calculation.