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Do the digital outputs handle all the audio? Or do I need to hook up the 5.1 channel outputs for SACDs and/or DVDs?
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DVD's (DD and DTS) use the digital output (coax or optical). SACD and DVD-A have to use the 5.1 outs.
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Which digital audio connection has better quality, digital coax or optical digital?
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Some will say yes, but IMHO they are one and the same. The difference is in the cost of the cable. You can get inexpensive ones that will work (as long as the workmanship is not inferior) or you can spend hundreds (thousands??) if you want. Cheapest solution is to purchase a plain ole' 75 Ohm composite video cable (the yellow one) for $5 and use it for the coax. The coax spec was built to use a 75 Ohm video cable, despite what the "Expressly made for DIGITAL!!!" marketing hype will tell you.