Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

start” Five-Year Period in order to become tax-free qualified distributions. Reg. § 1.408A- 10 , A-4(b), Example 3.

B. Rollover if participant already has a Roth IRA. If the participant had already established a Roth IRA prior to the rollover, the money rolled from the DRAC gets the benefit of the years the participant’s pre-existing Roth IRA has already completed towards the Roth IRA Five-Year Period (regardless of whether the DRAC distribution is rolled into the pre- existing Roth IRA or into a brand new Roth IRA). If the participant has already completed the Five-Year Period with respect to the existing Roth IRA(s) he owned prior to the rollover, then the rollover from the DRAC gets the benefit of that—even if the money was in the DRAC for less than five years. See Reg. § 1.408A-10 , A-4(b), Example 1. C. Danger: Rolling to participant’s first Roth IRA. The person who may be hurt by this rule is someone who had no prior Roth IRA, and had completed one or more years in his DRAC at the time he rolls a nonqualified distribution from the DRAC to a Roth IRA. He loses the years he had completed, and starts the 5-year clock over again. Because his rollover was NOT of a qualified distribution, only his basis in the DRAC ( i.e., the amount of his already-taxed contribution(s) to the DRAC) is treated as a “regular contribution” to the Roth IRA. The rest of the rollover is treated as “earnings,” meaning that it cannot be distributed tax-free except in a qualified distribution. Reg. § 1.408A-10 , A-4(b), Example 2. This will make little difference to a person who is rolling from the DRAC to a Roth IRA when he is under age 54½ because, absent disability, he will have to wait five or more years ANYWAY before he can have a qualified distribution from the Roth IRA. However, it could be tough for a person who has accumulated many years in the DRAC and then rolls to a Roth IRA shortly before reaching age 59½. If the first year for which he has ever owned a Roth IRA is the year he establishes a Roth IRA with his DRAC rollover, he will have to wait five more years to have a qualified distribution from that Roth IRA: Bryon Example: Bryon, age 38, establishes a $15,000 DRAC in 2006 in his employer’s 401(k) plan. He makes no further contributions to the DRAC. In 2026, he retires at age 58 and rolls over the DRAC (now worth $45,000) to a Roth IRA. This is his first Roth IRA; accordingly, computation of his Five-Year Period for the Roth IRA starts with the year of the rollover (2026), so he cannot have a qualified distribution from the Roth IRA until 2031. His basis in the DRAC ($15,000) will be treated as his only “investment in the contract” in the Roth IRA. Though he can withdraw that basis tax-free at any time, he cannot withdraw the post-2006 earnings ($30,000 at the time of the rollover) tax-free until 2031. If he had just waited until he had reached age 59½ before rolling the DRAC to a Roth IRA, the rolled distribution would have been a qualified distribution and the fresh-start rule would have applied only to post-rollover earnings (see “A”), not to ALL earnings.

DRAC accounting may not shift value

The plan must maintain separate records for the participant’s traditional and Roth accounts in the 401(k) plan until the DRAC has been completely distributed. § 402A(b)(2) , Reg. § 1.401(k)- 1(f)(2) . The IRS fears that employers will try to arrange the plan accounting so that profits are shifted into the DRAC; the regulation provides that any transaction or methodology that has the