What is Unearned Income?
Unearned Income Definition
Unearned Income is passive income, meaning that it accrues without active management.
Examples of Unearned Income
Sources of unearned income include, but are not limited to:
- Retirement accounts such as a 401(k) or annuity
- Interest from investments
- Veteran’s (VA) benefits
- Property income
- Welfare benefits
- Lottery winnings
How is Unearned Income Taxed?
Unearned income is taxed differently than regular, or earned, income.
Unearned income is not subject to payroll tax, for example.
Unearned income does, therefore, contribute to an individual’s overall tax burden.
During the accumulation phase, taxes are deferred on many sources of unearned income.
When it is taxed, it is taxed at the marginal rate, which is the percentage of tax paid at a particular tax bracket.
For example, an individual can make contributions to a 401(k) tax-free, however upon withdrawal the distributions are taxed based on the account holder’s current tax bracket.
Most sources of unearned income cannot be used to contribute to an individual retirement account, or IRA.
One of the only exceptions to this rule is alimony, which can be added to an IRA despite being taxed as unearned income.