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Compliance October 31, 2025
Understanding Distribution Taxes and Penalties
Knowing how participants will, or won't, be taxed on their DC plan distributions
Reported by PLANADVISER staff
Understanding how distributions from defined contribution plans are taxed is essential for participants planning their retirement income strategy. Depending on whether assets are held in a traditional pre-tax account or a Roth-designated account, the tax treatment and potential penalties can vary significantly, based on factors such as age, timing and type of asset pool.
Pre-tax distributions are generally taxed as ordinary income and may be subject to early withdrawal penalties, while Roth assets offer more favorable tax treatment under certain conditions. Additionally, required minimum distributions and the five-year rule for Roth accounts add layers of complexity that participants must navigate to avoid unnecessary taxes and penalties.
Qualified Plan Pre-Tax Assets
Distributions, from plans, of contributions made pre-tax are generally taxed as ordinary income; however, depending on the age of the participant making the distribution, there may be other rules.
If the participant is under age 59.5, distributions are generally subject to an early withdrawal 10% penalty if the money is not rolled over to another plan within 60 days. There are some exceptions to this rule, however.
Contributions made pre-tax are also subject to required minimum distributions, meaning that, in most cases, participants’ first RMD must be taken no later than April 1 of the calendar year following the calendar year in which they attain RMD age, or the calendar year in which they retire from the organization maintaining the plan, whichever is later. If participants are born after December 31, 1950, and before January 1, 1960, the first year for which an RMD must be withdrawn is the year the account owner turns 73. If they are born after December 31, 1959, the first year for which an RMD must be withdrawn is the year they turn 75.
Qualified Plan Roth Assets
For Roth assets in 401(k), 403(b) and governmental 457(b) retirement plans, there are no applicable early withdrawal penalties or RMDs.
There is a five-year rule for Roth DC plans, meaning that participants must wait until the completion of five tax years, starting January 1 of the year they made their first contribution, to be eligible for a qualified distribution of earnings on which they would pay no taxes.
This five-year period must be combined with one of the following conditions: attainment of age 59.5, disablement or death.
For those older than 59.5, distributions are tax-free so long as the five-year rule is met, otherwise the investment earnings will be subject to ordinary income tax.
