You’ve clocked out of work for the last time, and you’re ready to kick off your retirement in style. Umbrella drinks, catching up on your hobbies, and … what’s that? Hold on, there’s someone at the door.
Oh. It’s Uncle Sam.
I’m sorry to be the bringer of bad news, but calling it quits on your career doesn’t magically ward off the Internal Revenue Service. Indeed, the tax man will still demand his cut from most (but not all) of the income you collect in retirement—and tax rules being what they are, many sources of income are treated differently from one another.
Today, we’re going to provide you with a quick reference guide to how numerous types of retirement income are taxed. This information is vital because it will give you a much clearer picture of how much income you’ll actually net in retirement … and because knowing the rules can help you build a tax-efficient retirement strategy that could end up saving you a significant sum of money.
Disclaimer: This article does not constitute individualized tax nor investment advice. This information appears for your consideration and as general information, not as personalized tax or investment recommendations. Act at your own discretion.
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Table of Contents
Is Retirement Income Taxable?
In a word: Yes.
In several words: Many forms of retirement income are taxable. But some aren’t. And others are only taxable in specific situations. And different sources of retirement income may be taxed at different rates and have other varying rules.
Today, my goal is to help you better understand how your retirement income might be taxed so you can make a more accurate estimate about how much money you’ll really be working with when you hang up your office badge.
Editor’s Note: This is a federal-only look at retirement income taxation. State, cities, and municipalities may levy their own taxes on these retirement income sources as well.
Related: 8 Special Tax Breaks for Senior Citizens
Retirement Accounts
First, let’s look at a wide variety of tax-advantaged accounts that are either explicitly designed to help people save for retirement, or have another primary purpose but can also be used to build a nest egg.
Tax-Deferred Retirement Accounts
Tax-deferred retirement accounts are accounts that are funded with pre-tax dollars and allow those dollars to grow tax-free within the account. The money is only ever taxed when you withdraw it.
This category covers both personal and workplace accounts, including traditional individual retirement accounts (IRAs), 401(k)s, solo 401(k)s, 403(b)s, 457(b)s, SIMPLE IRAs, Simplified Employee Pension (SEP) IRAs, self-directed IRAs (SDIRAs), and Keogh Plans.
Distributions from tax-deferred retirement accounts are taxed as ordinary income (see your federal tax brackets) but aren’t subject to payroll taxes, such as Social Security, Medicare or the Additional Medicare Tax (only applicable to high-earners).
Money left in tax-deferred retirement accounts are subject to required minimum distributions (RMDs) starting at age 73. (However, starting in 2033, the new starting age will be 75.)
Distributions aren’t subject to the 3.8% net investment income tax (NIIT).
Non-qualified early withdrawals (generally prior to 59½, though certain exceptions apply) encounter a 10% early withdrawal penalty.
Related: 10 Best Fidelity Funds to Own
Tax-Exempt Retirement Accounts
You can think of tax-exempt retirement accounts as the inverse of tax-deferred. You fund the account with money that has already been taxed, but then the money is allowed to grow tax-free while in the account, and you aren’t taxed upon withdrawal.
Tax-exempt retirement accounts include Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457(b)s, Roth solo 401(k)s, Roth SEP IRAs, and Roth SDIRAs.
Withdrawals of contributions to tax-free retirement accounts are generally tax- and penalty-free regardless of age.
If you withdraw earnings from a Roth account …
— … and you have both reached age 59½ and held the account for at least five years, your withdrawals will generally be tax-free.
— … but you are either not age 59½ or older, or haven’t held the account for at least five years, your withdrawals will generally be subject to taxes at your ordinary income rates, as well as a 10% penalty. (Like with tax-deferred accounts, some exceptions apply.)
Related: 10 Best Vanguard Funds to Buy
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Health Savings Accounts (HSAs)
Distributions from a health savings account (HSA) are tax-free at any age if funds are spent on qualified health care expenses.
Withdrawals for non-qualified health care expenses taxed as ordinary income if you’re age 65 or older.
Withdrawals for non-qualified health care expenses taxed as ordinary income, and subject to a 20% penalty if you’re under age 65.
Related: New Standard Deduction for 2025: How Much Will Your Taxable Income Be Lowered?
Pensions
Pension distributions are generally taxed as ordinary income unless you made after-tax contributions to your pension plan.
Importantly, these taxes apply whether you receive regular income from a pension or take a lump-sum distribution. So if you favor the latter, just understand that you will have a significant tax bill for the year in which you made the withdrawal.
However, you generally have the option of rolling a pension over into an employer-sponsored account—like a 401(k), if your employer’s plan allows for it—or an IRA, without fear of tax consequences. This is useful if you want more control over how your pension money is invested. It also sets up the potential to leave more to your spouse in the event of your death, as pensions often pay surviving spouses a reduced rate.
Taxable Accounts
Now, I’ll move on to financial accounts that enjoy no tax advantages.
Brokerage Accounts
Investments held in taxable brokerage accounts can generate several types of tax consequences:
— Capital gains: The following rules apply to the sale of stocks, bonds, mutual funds, exchange-traded products (including ETFs and ETNs), closed-end funds (CEFs), options, futures, and other investments typically available in a brokerage account:
Short-term capital gains (held for a year or less) are taxed at ordinary income tax rates.
Long-term capital gains are taxed at capital gains tax rates (0%, 15% or 20%).
Further, these gains may be subject to the 3.8% NIIT if your modified adjusted gross income (MAGI) exceeds certain thresholds.
— Dividend income: Qualified dividends are taxed as long-term capital gains. Non-qualified dividends are taxed as ordinary income.
— Interest income: Taxed as ordinary income, with a couple notable exceptions:
Treasury bond interest is exempt from state income tax.
Municipal bond interest is exempt from federal income tax, and potentially state and municipal income tax depending on the bond and where the owner resides.
— Capital gains distributions: In addition to dividends and bond interest, investment funds (mutual funds, exchange-traded funds, closed-end funds, etc.) may pay out capital gains distributions, which represent your portion of the proceeds from sales of assets from within the fund’s portfolio. Depending on your holding period and the nature of the capital gains, you might face ordinary income tax rates, long-term capital gains rates, or a tax-free return of capital.
— Return of capital (RoC): Occasionally, an investment will pay another type of distribution: a return of capital. It represents the return of all or a portion of your original investment. RoC isn’t taxed; instead, it reduces your cost basis in the investment, allowing for greater capital gains (or losses) when you dispose of the asset.
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Savings Products
Savings products include checking and savings accounts, certificates of deposit (CDs), money market accounts (MMAs), and other cash equivalents.
Any interest earned from these products is generally taxed as ordinary income. However, you’ll typically only receive a Form 1099-INT from your financial institution if you have earned more than $10 in interest.
Importantly, you’re taxed only on the earned interest—you do not need to pay taxes on deposits.
Related: What Is the Social Security COLA?
Social Security Benefits
Depending on your income and tax filing status, up to 85% of your Social Security income is subject to ordinary income taxes.
You can check out a fuller explanation by reading our primer on how Social Security benefits are taxed.
Work (Employee or Contractor)
In some cases, retirement doesn’t necessarily mean completely breaking away from work. Fortunately, the rules for taxing work income are the same regardless of whether you’re in retirement.
Employee (Form W-2)
If you work in retirement as an employee, your earnings will generally be taxed as ordinary income. You’ll also pay the employee’s portion of payroll taxes, such as Social Security and Medicare taxes.
Contractor (Form 1099-NEC)
If you work in retirement as a contractor, your income will generally be taxed as ordinary income. Additionally, you’ll also pay the employee’s and employer’s portions (you’re your own employer if you don’t work for a company as an employee) of payroll taxes.
Related: 6 HSA Money Mistakes to Avoid
Insurance
Retirees commonly will receive income from one or more insurance products. Here’s a quick look at how the most popular life insurance products’ income is taxed.
Life Insurance Proceeds
Life insurance proceeds received as a beneficiary are generally tax-free.
Permanent Life Insurance Dividend Income
Permanent life insurance policies with cash value balances that pay dividends generally provide tax-free income to the recipient since the IRS deems this as a return of premium.
Annuities
The portion received from the annuity as principal is tax-free, while earnings are taxed as ordinary income unless you purchased the annuity with pre-tax funds.
Related: What Is a Backdoor Roth Conversion? [Retirement Strategy for High-Earners]
Real Estate
Retirees who own a home will likely sell it at some point or another down the road. And a few, more ambitious, retirees might decide to earn money as a landlord in retirement.
Both situations come with their own tax consequences, though the rules are exactly the same regardless of whether you’re retired.
Home Sales
The sale of your primary residence can have up to $250,000 (or $500,000 for married couples) in gains excluded from taxation, if certain use and ownership criteria are met.
Rental Real Estate
Generally, rental income is taxed as ordinary income. However, if you meet certain criteria, any home rental income resulting from the rented use of your home for 14 days or fewer per year is generally tax-free income.
Any sale of rental property is fully subject to short- or long-term capital gains, and recaptured depreciation might factor in as well.
Related: 7 Best Schwab Funds to Own
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Your Retirement Plan Can’t Ignore Taxes
For many of us, taxes are automatically taken out of our paychecks, so it’s easy for us to forget about taxes as we draw out our retirement plans and estimate how much income we’ll be working with.
But the cut Uncle Sam takes can be a lot more than a rounding error—it can translate to hundreds or even thousands of dollars each month that you don’t actually have to budget around.
If you’re still of working age and have a firm grasp on taxes and how they impact your current situation, you might have the necessary tools to incorporate taxes into your retirement plan. But if you don’t have much tax knowhow, or want to ensure you don’t overlook any major tax pitfalls, it might make sense to talk to a financial professional who can build a holistic plan with the IRS in mind.
Related: Are You Saving Enough for Retirement?
Related: 12 Best Long-Term Stocks to Buy and Hold Forever
As even novice investors probably know, funds—whether they’re mutual funds or exchange-traded funds (ETFs)—are the simplest and easiest ways to invest in the stock market. But the best long-term stocks also offer many investors a way to stay “invested” intellectually—by following companies they believe in. They also provide investors with the potential for outperformance.
So if your’e looking for a starting point for your own portfolio, look no further. Check out our list of the best long-term stocks for buy-and-hold investors.
Related: 9 Best Monthly Dividend Stocks for Frequent, Regular Income
The vast majority of American dividend stocks pay regular, reliable payouts—and they do so at a more frequent clip (quarterly) than dividend stocks in most other countries (typically every six months or year).
Still, if you’ve ever thought to yourself, “it’d sure be nice to collect these dividends more often,” you don’t have to look far. While they’re not terribly common, American exchanges boast dozens of monthly dividend stocks.
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