How are distributions from a tax-qualified retirement plan treated for tax purposes?

Distributions from a tax-qualified retirement plan are treated as ordinary income for tax purposes. This means that when individuals withdraw funds from their retirement accounts—such as a 401(k) or an IRA—those funds are subject to income tax at the individual's applicable tax rate at the time of withdrawal.

The reason for this classification stems from the fact that contributions to these plans are often made with pre-tax dollars, allowing individuals to defer taxes on both the contributions and any investment gains until they take a distribution. While the money grows tax-deferred within the plan, the government collects taxes when it is distributed as ordinary income. This treatment contrasts with capital gains or qualified dividends, which are taxed at different rates and under different circumstances. Tax-exempt income refers to certain types of income that are not subject to federal taxes, but this does not apply to distributions from tax-qualified retirement plans.