Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

How are withdrawals from a Traditional IRA treated for tax purposes?

1. Tax-free regardless of age

2. Partially taxed based on contribution

3. Taxed as ordinary income

4. Taxed at a capital gains rate

The correct answer is: Taxed as ordinary income

Withdrawals from a Traditional IRA are taxed as ordinary income when funds are taken out. This taxation occurs because Traditional IRAs are funded with pre-tax dollars. Therefore, individuals receive a tax deduction for contributions to the account during the funding years, which means that taxes are deferred until the money is withdrawn. When a person withdraws funds from a Traditional IRA, the amount withdrawn is considered taxable income and must be included in the individual's gross income for that tax year. This is true regardless of the individual's age at the time of the withdrawal, although there are additional penalties for withdrawing funds before reaching age 59½, barring certain exceptions. The other choices reflect misunderstandings of how Traditional IRAs operate. Withdrawals are not tax-free, as they are subject to income tax. They are not partially taxed based on contributions, as all withdrawals are treated uniformly as ordinary income. Finally, the withdrawals are not taxed at a capital gains rate, as Traditional IRA withdrawals do not qualify for capital gains treatment since the funds are taxed as income rather than investment gains.