What does "pro-rata" distribution refer to in retirement accounts?

Pro-rata distribution refers to a method of distributing funds from retirement accounts in a way that maintains the proportional balance between pre-tax and after-tax contributions. This means that if an individual decides to take a withdrawal from their retirement account, the funds they receive will reflect the same ratio of pre-tax to after-tax contributions that exist in the account as a whole.

For example, if an account has a mix of $80,000 in pre-tax contributions and $20,000 in after-tax contributions, a pro-rata distribution would ensure that any withdrawal taken will consist of 80% pre-tax funds and 20% after-tax funds. This is particularly important because it affects the tax implications of the withdrawal; pre-tax funds are generally subject to income tax upon withdrawal, whereas after-tax contributions can be withdrawn tax-free.

Understanding pro-rata distributions is crucial for individuals managing their retirement accounts, as it influences both the tax burden they may face upon withdrawal and their overall retirement strategy. It helps them plan effectively and avoid unintended tax consequences.