When withdrawing from a nonqualified plan, which portion is taxable?

When withdrawing from a nonqualified plan, which portion is taxable?

• A. Principal contributions are taxable.
• B. Earnings are taxable.
• C. Both principal and earnings are taxable.
• D. No portion is taxable.

Answer: (B)

When you withdraw from a nonqualified plan, you’re taxed only on the earnings portion. The principal contributions are after-tax dollars, meaning you’ve already paid taxes on that money, so a return of your original investment isn’t taxed again. The earnings grow tax-deferred, and you owe ordinary income tax on that growth when you take distributions. For example, if you contributed $10,000 of after-tax money and the account grows to $15,000, the $5,000 of earnings is taxable, while the $10,000 you put in comes back tax-free. This differs from qualified plans where distributions are taxed on the total amount.

When you withdraw from a nonqualified plan, you’re taxed only on the earnings portion. The principal contributions are after-tax dollars, meaning you’ve already paid taxes on that money, so a return of your original investment isn’t taxed again. The earnings grow tax-deferred, and you owe ordinary income tax on that growth when you take distributions. For example, if you contributed $10,000 of after-tax money and the account grows to $15,000, the $5,000 of earnings is taxable, while the $10,000 you put in comes back tax-free. This differs from qualified plans where distributions are taxed on the total amount.