Under the current tax law, amounts withdrawn from your plan account - both salary deferrals and earnings - will be taxed to you as ordinary income.  So, if you withdraw $10,000 of deferrals and earnings from your account in a certain year, you must generally include that amount in your gross income for tax purposes.

However, if you receive your distribution in a single sum that qualifies as a "lump-sum distribution," you may be able to use a special forward averaging method that can help you reduce taxes.

You may also be able to avoid immediate taxation by transferring your taxable distribution to a "rollover" individual retirement account (IRA).  If you make a direct transfer, you won't owe any taxes until you make withdrawals from the rollover IRA.  

01/01/2008