For retirees, income can arrive from many different sources—Social Security, pensions, investments, and more. A common and costly mistake is assuming all this income is treated the same by the IRS. Understanding the difference between taxable and tax-exempt income is crucial for accurate budgeting and avoiding an unexpected tax bill. This guide breaks down the most common income types for seniors for the 2024 tax year (the return you file in 2025).
Income That Is Generally TAXABLE
This is income that you must report to the IRS and will likely pay tax on, depending on your total income, deductions, and credits.
- Distributions from Traditional Retirement Accounts: Money you withdraw from Traditional IRAs, 401(k)s, 403(b)s, and similar employer-sponsored plans is generally fully taxable as ordinary income.
- Most Pension and Annuity Payments: Like traditional retirement accounts, most pension payments are taxable. (Exception: If you contributed after-tax money, a portion may be tax-free).
- Wages and Self-Employment Income: If you’re still working part-time or have a side business, that income is taxable.
- Interest and Ordinary Dividends: Interest from bank accounts, CDs, and most corporate bonds is taxable. Most dividends are also taxable.
- Capital Gains: When you sell an asset—like stocks, bonds, or real estate—for more than you paid for it, the profit is a capital gain and is taxable.
The Big One: How Social Security Benefits Are Taxed
This is the most confusing area for many seniors. Your Social Security benefits can be tax-free, partially taxable, or mostly taxable, depending on your “provisional income.”
Calculating Your “Provisional Income”
To determine if your benefits are taxable, the IRS has you calculate your provisional income. The formula is:
Your Adjusted Gross Income (AGI)
+ 50% of Your Social Security Benefits
+ Your Tax-Exempt Interest (like from municipal bonds)
= Your Provisional Income
Once you have that number, you can use the table below to see how you’re affected.
| Filing Status | Provisional Income Level (for 2024) | Portion of Benefits That May Be Taxed |
|---|---|---|
| Single, Head of Household, Qualifying Widow(er) |
Below $25,000 | 0% (None of your benefits are taxed) |
| $25,000 – $34,000 | Up to 50% | |
| Above $34,000 | Up to 85% | |
| Married Filing Jointly | Below $32,000 | 0% |
| $32,000 – $44,000 | Up to 50% | |
| Above $44,000 | Up to 85% |
Income That Is Generally TAX-FREE (Exempt)
This is income you typically do not have to report to the IRS and will not pay federal income tax on.
- Qualified Distributions from Roth Accounts: Withdrawals from a Roth IRA or Roth 401(k) are completely tax-free, provided you’ve had the account for at least five years and are over age 59½.
- Gifts and Inheritances: In most cases, the person receiving a gift or inheritance does not pay tax on it. (Any tax due is typically the responsibility of the giver’s estate).
- Life Insurance Proceeds: Payouts from a life insurance policy to a beneficiary due to the death of the insured person are not taxable.
- Reverse Mortgage Payments: The money you receive from a reverse mortgage is treated as a loan, not income, and is therefore tax-free.
- Sale of Your Primary Home: If you meet the ownership and use tests (lived in the home for 2 of the last 5 years), you can exclude up to $250,000 of profit if single, or up to $500,000 if married filing jointly.
- Federal Tax-Exempt Interest: Interest earned from municipal bonds is generally exempt from federal income tax.
- Most Veterans’ Benefits: Benefits paid by the Department of Veterans Affairs (VA) are typically tax-exempt.
Pro Tip: Don’t Forget State Taxes!
This guide focuses on federal income tax rules. Your state may have very different rules! For example, some states don’t tax pension income up to a certain limit, while others don’t tax Social Security benefits at all. Always check your state’s Department of Revenue website for specific rules that apply to you.
Disclaimer: This information is for educational purposes and should not be considered legal or tax advice. Tax laws are complex and change over time. Please consult with a qualified tax professional to discuss your specific financial situation.
