The age-55 rule only eliminates the 10% early-distribution penalty. It does on eliminate that income tax on the earnings. The earnings are income-tax free only if you have reached age 59½ or are disabled (or if you roll the earnings over to another Roth account).
Because the distribution is eligible for rollover, the fund manager is required to withhold 20% of the taxable amount of the distribution (the earnings are the taxable portion) for income taxes. This has nothing to do with the 10% early-distribution penalty.
Prior to making the distribution your 403(b) plan administrator was required to give you information explaining these tax consequences unless you waived that requirement.
The tax code establishes the rules for qualified distributions (tax free distribution of earnings) in from a designated Roth account in a qualified retirement plan like a 403(b) in section 402A(d)(2). This section refers to section 408A(d)(2)(A) (without regard to clause (iv) thereof):
(A)In general
The term “qualified distribution” means any payment or distribution—
(i)made on or after the date on which the individual attains age 59½,
(ii)made to a beneficiary (or to the estate of the individual) on or after the death of the individual,
(iii)attributable to the individual’s being disabled (within the meaning of section 72(m)(7))
The age-55 rule is defined in section 72(t)(2)(A) of the tax code where it describes exceptions to the early-distribution penalty. It has nothing to do with determining whether the earnings are subject to income tax.
