Certified Plan Sponsor Professional (CPSP) Practice Exam

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How are Voluntary After-tax contributions taxed when withdrawn from the plan?

They are fully tax-exempt
Contributions are taxed, but earnings are tax-exempt
Earnings are taxed, but contributions are tax-exempt
Both contributions and earnings are taxed

The correct answer is: Earnings are taxed, but contributions are tax-exempt

When it comes to Voluntary After-tax contributions, the taxation upon withdrawal operates under specific rules. Contributions made as after-tax are already taxed before they are contributed to the retirement plan. Therefore, when these contributions are withdrawn, they are not subject to additional taxation, meaning they are tax-exempt. On the other hand, any earnings that accrue on those after-tax contributions are subject to taxation upon withdrawal. This reflects the common tax treatment of after-tax contributions, where the principal (the contributions) are not taxed again, but the growth or earnings generated over time are taxed as ordinary income when distributed. Hence, the correct understanding is that earnings are taxed upon withdrawal, while the contributions themselves remain tax-exempt. This aligns with the tax treatment established for Voluntary After-tax contributions in retirement plans.