Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

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When withdrawing from a qualified plan, how is the distribution generally taxed?

It is completely tax-free
It is taxed at a capital gains rate
The entire withdrawal is taxed as income
Only the earnings are taxed

The correct answer is: The entire withdrawal is taxed as income

When withdrawing from a qualified plan, the entire withdrawal is typically taxed as ordinary income. Qualified plans, such as 401(k)s and traditional IRAs, allow participants to make tax-deferred contributions. This means that taxes on those contributions and any earnings are postponed until the money is withdrawn. When distributions are taken from these plans, they are added to the retiree's taxable income for the year in which the withdrawal occurs. This is because the contributions made to the plan were deducted from taxable income in the year they were made. Therefore, when participants eventually withdraw money from their qualified plan, they are required to pay income tax on the total amount withdrawn, including both contributions and earnings. This taxation method is designed to incentivize saving for retirement by allowing growth without immediate tax implications, but it ensures that the government ultimately collects taxes on those funds when they are distributed.