Life and Death Planning for Retirement Benefits

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Chapter 5: Roth Retirement Plans 263
money; the IRS calls this the “earnings”). Hopefully, the “earnings” will NEVER be taxed, because
they will come out eventually in the form of a tax-free qualified distribution .
But if there is a nonqualified distribution, the earnings cannot come out tax-free.
Accordingly, we need to determine how much of any nonqualified distribution represents a return
of the participant’s basis (tax-free) and how much is considered earnings (taxable), and here’s
where we find the difference between Roth IRAs and DRACs. With a Roth IRA, the participant’s
own contributions (i.e., the after-tax money) come out first. Accordingly, even
nonqualified Roth IRA distributions are income tax-free until the entire basis has been distributed.
With DRACs, in contrast, there is no special rule allowing the participant’s basis to come
out first. So, the regular rule of will apply—the “cream-in-the-coffee rule,” under which
any distribution carries out proportionate amounts of the participant’s basis (after-tax money) and
earnings (pretax money). Reg. , A-3; see Thus, every nonqualified
distribution from a DRAC will be partly taxable unless either (1) there has been no appreciation
in the account since the original contributions or (2) the earnings portion is rolled over .
The participant’s DRAC is treated as a separate account from the participant’s traditional
accounts in the plan for purposes of applying Thus, distributions can be taken
from each category (traditional or Roth) separately, without their being aggregated for purposes of
the “cream-in-the-coffee rule.”
However, if the participant has more than one DRAC inside a single 401(k) plan (for
example, an elective deferral account and a rollover account), these are treated as a single account
for purposes of Reg. , A-9(a). The only exceptions to this are: If an account is
divided between the participant and his spouse pursuant to a QDRO, each spouse’s share of the
employee’s DRAC is treated as a separate account (or “separate contract,” in the lingo o see
C)); and, the plan can split the DRAC into multiple separate accounts for the participant’s
multiple beneficiaries after the participant’s death, and each such account will be treated as a
separate “contract” under Reg. A-9(b).
5.7.06 Rollovers of DRAC distributions: General rules
A distribution from a DRAC may be rolled over only to another DRAC or to a Roth IRA.
Reg. , A-5(a). See for the rules for DRAC-to-DRAC rollovers,
for DRAC-to-Roth IRA rollovers.
Though both direct rollovers and indirect (60-day) rollovers are permitted (se for
the difference), different rules apply to these two types of rollovers:
 If a DRAC pays a distribution from the participant’s account directly to another DRAC
(trustee-to-trustee transfer or direct rollover), that is treated as a separate distribution from
“any amount paid directly to the employee,” for purposes of determining how much of
each of these “separate distributions” is after-tax money and how much is pretax money.
Reg. , A-5(a), third sentence; A-6(a). Although this regulation addresses only
direct rollovers from one DRAC to another, Notice 2009-68, 2009-39 IRB 423, at p. 429,
provides the same rule for rollovers from any QRP to any other eligible retirement plan;
see A).
 If a distribution is paid to the participant (rather than being rolled directly to another plan
or IRA), and the participant rolls over only part of the distribution (using a 60-day rollover),