Pro rata is a financial term that indicates the manner in which a distribution will be made. Understanding the pro rata definition is helpful in a variety of circumstances, including the distribution of capital gains, insurance payments, as well as distributions of the assets in an estate. This guide will explain what pro rata is, when it’s used, and other helpful information so that you feel confident should you encounter a pro rata distribution.
What is pro rata?
Pro rata is a term derived from Latin that essentially means “proportionate.” The term is used to describe a proportionate allocation or distribution of something, such as an asset or capital payout. The asset, sum, or item being allocated is distributed in either equal or proportionate amounts.
When it comes to proportionate distributions, a pro rata calculation is used to determine how much an individual should pay or charge relative to their stake or involvement in the given matter. (This could be an asset, property, venture, or service, for instance.) Performing a pro rata calculation is often called prorating, resulting in the prorated amount, which is a familiar concept to most.
What does pro rata mean in simple terms?
In simple terms, pro rata is used such that everyone involved in a scenario gets their fair share in proportion to the whole.
For instance, let’s say that you’re being quoted for an annual auto insurance premium. However, you’re signing up part way through the year. Would you feel that it is fair to be charged for the entire year, considering you’re only using the policy for part of the year?
Probably not.
Instead, your insurance would use a pro rate calculation so that you only end up paying the share of the premium that you’d actually be using that year.
When is pro rata used?
Pro rata is used in many different areas. The pro rata calculation, which we’ll go over later, can be used to determine dividend payments to shareholders, or determine the premium due for an insurance policy that only covers part of the year.
It can also be used to determine the taxable amount on a retirement account distribution, holiday pay for employees, and many other areas of business. Last but not least, it can be used to calculate asset distribution amounts to heirs from a Trust or estate.
How is pro rata calculated?
The pro rata calculation can typically be applied to any scenario, although the specifics may be unique.
Here is the most simple representation of the pro rata formula:
Prorated Amount = (Total Value) x (Proportion You’re Entitled To)
What is an example of pro rata?
Let’s work through an example to help illustrate how the pro rata calculation is applied.
Imagine that you’re an employee at a company, and you’re entitled to receive a $5,000 bonus this year. However, you decide to leave the company on August 15th and don’t finish out the year. Your employment contract states that if you leave the company at any point in the year, you are still entitled to a pro rata share of your bonus.
To calculate your pro rata share, you would take the total value of your bonus and multiply it by the proportion you’re entitled to.
There are 365 days in the year, and there are 226 days between January 1st and August 15th.
Pro rata share: 226 / 365 = 0.62 or 62%
Now that we have the share, we can calculate the pro rated bonus that you’re entitled to:
Bonus = $5,000 x 0.62 = $3,100
Based on this calculation, you’re entitled to a bonus of $3,100 if you leave your job on August 15th, based on your having worked 62% of the calendar year.
Other common questions about pro rata
Have some remaining questions or points of clarification regarding pro rata? Here are the answers to some of the most frequently asked questions about pro rata, right here! Keep reading to gain further insight and clarity on the subject.
What is pro rata payment?
A pro rata payment is a payment made out to an individual utilizing the pro rata calculation. The amount you receive is typically proportionate to what you’re entitled.
Let’s use a pro rata dividend payment as an example.
Publicly-traded companies use pro rata to calculate how dividends are paid out to shareholders. The dividend payment a shareholder receives is proportionate to the number of shares they own, relative to the total number of shares available.
Let’s say Company X sold a total of 500 shares. You own 20 of these shares. Company X is paying out $1,000 in dividend payments.
Pro Rata = (20 shares / 500 shares, or 4%) x $1,000 = $40
Because you won 4% of the shares, you are entitled to 4% of the dividend payment. Therefore, for a total dividend payout of $1,000, you will receive $40.
(Note that this example uses oversimplified numbers for easy comprehension.. Most companies have millions of shares and utilize more complex methods of pro rata calculations.)
What is another name for pro rata?
Synonyms for pro rata include:
Prorate
Prorated
Respectively
Proportionately
In Proportion
Ad Valorem
According to the calculate share
What is the difference between prorated and pro rata?
The terms pro rata and prorated are used interchangeably and essentially mean the same thing: dividing a payment or asset proportionately to the amount an individual is entitled to.
You could argue that pro rata is the term describing the concept, while prorated is the resulting number that was calculated using this concept.
Applying pro rata to your estate plan
The term “pro rata” might sound like something foreign and complex at first, but once you understand it, it’s surprisingly simple. Put very simply, it’s a calculation used such that everyone gets their fair share.
In estate planning specifically, the term “pro rata” indicates how an estate’s assets should be divided and distributed among the decedent’s beneficiaries. Pro rata in this case is also synonymous with per capita. If the decedent had 4 children and left in his wishes that he wanted his estate distributed “pro rata” amongst his children, then this means that the estate assets would be divided into 4 equal portions, with an equal portion distributed to each of his children. This is as opposed to other methods of dividing an estate, such as “per stirpes.” We explain the difference between pro rata vs. per stirpes in detail here.
If you would like for your estate to be distributed in any specific way amongst your beneficiaries, we highly recommend that you update your estate plan accordingly. Not sure where to start? At Trust & Will, we’re here to help keep things simple. You can create a fully customizable, state-specific estate plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today!
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