Final answer:
Distributions from non-tax qualified retirement accounts like 401(k)s and Traditional IRAs after the age of 59 1/2 are generally taxable. These accounts are designed with tax-deferred growth, where taxes are paid upon withdrawal, potentially at a lower tax bracket in retirement. Roth IRA distributions, on the other hand, can be tax-free since they are funded with after-tax dollars.
Step-by-step explanation:
When an individual reaches the age of 59 1/2 and starts taking distributions from their non-tax qualified retirement accounts such as a 401(k) or Traditional IRA, the money withdrawn is generally taxable. These retirement plans allow workers to invest in various vehicles like stocks, bonds, and annuities with tax-deferred growth, meaning taxes on earnings are delayed until funds are withdrawn. Employers often contribute a fixed amount to these accounts, known as defined contribution plans, which are portable across jobs and aim to offer growth that outpaces inflation.
For Traditional IRAs, distributions are typically fully taxable because contributions to these accounts are made with pre-tax dollars. The principle behind these accounts is that you defer taxes on contributions and earnings until retirement, when you may potentially be in a lower tax bracket. However, for Roth IRAs, which are funded with post-tax dollars, the distributions after age 59 1/2 are generally tax-free because taxes on contributions have already been paid upfront.
It is crucial to note that this information applies to typical cases, but specific circumstances, such as early withdrawals or non-deductible contributions, can affect the taxable nature of a distribution. Consulting with a tax professional is recommended for personal financial advice.