Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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C. Favorable effect on basis recovery . Rolling from a DRAC to a Roth IRA enables the participant (once the rollover is completed) to withdraw his own contributions tax-free from the Roth IRA while leaving any “earnings” inside the account, something he could NOT do with the DRAC, because the Roth IRA has more favorable rules for recovery of basis than a DRAC. Compare ¶ 5.2.06 with ¶ 5.7.05 . D. Rollover when basis is higher than market value. There is a special rule for determining basis in the Roth IRA when there is a rollover into the Roth IRA from a DRAC, if the employee’s basis in the DRAC exceeded the DRAC’s value on the date of distribution: If the employee takes a distribution of the entire balance of his DRAC, and rolls PART of that distribution to a Roth IRA by means of a 60-day rollover, and at the time of the distribution his basis in the DRAC exceeded the market value of the DRAC, the excess basis is treated as a regular contribution to the Roth IRA ( i.e., it is added to the employee’s basis in the Roth IRA). Reg. § 1.408A-10 , A-3(b). Does this ability to preserve “excess basis” also apply to direct DRAC-to-Roth-IRA rollovers (not just 60-day rollovers), and to a rollover of the entire distribution (not just to partial rollovers)? The regulation specifically mentions only partial 60-day rollovers. The IRS may have intended that carryover of “excess” basis would also apply for direct rollovers of the entire account balance, by its cross reference to Reg. § 1.402A-1 , A-6 (see ¶ 5.7.07 (C)); it’s not clear. Preserving the “excess basis” could be important in two situations. One is if the participant or beneficiary later takes a nonqualified distribution from the Roth IRA. Such a distribution would be includible in income only to the extent the distribution exceeded the participant’s basis. ¶ 5.2.06 . The other advantage of preserving basis would occur if the individual cashed out all of his Roth IRAs, and the total sum received was less than the individual’s basis in the account, so the individual would be entitled to a loss deduction. See ¶ 8.1.02 . The Five-Year Period for a Roth IRA begins January 1 of the first year the participant has any Roth IRA ( ¶ 5.2.05 ), regardless of whether the Roth IRA holds money rolled over from a DRAC; whatever holding period the DRAC owner had established in the plan that originally held the DRAC does NOT carry over to the Roth IRA, regardless of whether the DRAC-to-Roth-IRA rollover is a “direct rollover” or a “60-day rollover.” Reg. § 1.408A-10 , A-4. With direct DRAC-to-DRAC rollovers, Congress specified that the employee’s holding period carries over from one DRAC to the other. § 402A(d)(2)(B) ; see ¶ 5.7.07 (D). However, Congress said nothing about a carryover of holding period in the case of a DRAC-to-Roth-IRA rollover, so the Regulations allow no such carryover. This rule will adversely affect some (see “C”), but is not the disaster it at first appears (see “A” and “B”). A. Rollover of a qualified distribution. If the DRAC distribution that is rolled over to the Roth IRA is itself a qualified distribution ( ¶ 5.7.04 ), then the entire rollover amount is treated as a “regular contribution” to the Roth IRA. Reg. § 1.408A-10 , A-3(a). A regular contribution can be withdrawn from a Roth IRA at any time, income tax-free. ¶ 5.2.06 . Thus, only the post-rollover earnings on the rollover amount may be subject to a “fresh DRAC-to-Roth IRA rollovers: Effect on Five-Year Period