For retirees living on fixed incomes, rising everyday costs can put additional pressure on household budgets. Gasoline prices are up 27.4% year over year, while food and housing costs are also increasing. Understanding which types of retirement-related income the Internal Revenue Service (IRS) generally excludes from federal taxable income can help retirees estimate their actual disposable cash flow.
Retirement income is not simply divided into taxable and tax-free categories. Some income is fully taxable, some is only partly taxable, and some can be excluded from federal taxable income when specific conditions are met. The following five categories are common, but the final tax treatment depends on the account type, holding period, income level and state rules.
Life insurance death benefits are generally not taxable
When a retiree dies, life insurance death benefits paid to a spouse, child or other beneficiary are generally not treated as federal taxable income. The proceeds are not technically retirement income, but they can be important to the surviving household's cash flow.
For example, if a spouse holds a $500,000 life insurance policy and the beneficiary receives a $500,000 death benefit after the policyholder dies, the beneficiary generally does not owe federal income tax on that principal amount.
Interest paid in addition to the death benefit is generally taxable. Special tax rules may also apply if the policy was transferred for valuable consideration, so not every payment associated with a life insurance policy should automatically be treated as tax-free.
Qualified Roth IRA and Roth 401(k) withdrawals
Qualified distributions from Roth IRAs and Roth 401(k)s are generally exempt from federal income tax. Contributions to Roth accounts are made with money that has already been taxed and typically do not provide an upfront deduction. In return, qualifying withdrawals in retirement are generally not taxed again.
Roth IRA withdrawals typically must satisfy both the five-year rule and an age requirement, such as the account holder being at least 59 1/2. The five-year period generally begins with the tax year of the account holder's first Roth IRA contribution. Disability or the account holder's death may also qualify under certain rules. Roth 401(k) distributions must likewise meet the applicable requirements for qualified withdrawals.
For example, a retiree who withdraws $30,000 from a Roth IRA generally will not include that amount in taxable income if the distribution is qualified. Not every Roth withdrawal is automatically tax-free, however. The investment earnings portion of a nonqualified distribution may be taxable and may also face an additional 10% tax.
Some municipal bond interest is exempt from federal tax
States, local governments and other public entities issue municipal bonds to fund public projects. Interest from many municipal bonds is exempt from federal income tax, meaning it does not directly increase federal taxable income for retirees seeking investment income.
If an investor receives $5,000 in tax-exempt interest from qualifying municipal bonds, that interest generally is not included in federal taxable income. Interest from some private activity municipal bonds may be subject to the alternative minimum tax, or AMT, and certain municipal bond interest is taxable at the federal level.
State and local treatment varies. An investor may owe no federal tax on the interest but still face state or local income tax depending on the investor's residence and where the bond was issued.
Tax-exempt municipal bond interest also counts toward the IRS calculation used to determine whether Social Security benefits are taxable. As a result, the interest can push a retiree's combined income above a relevant threshold, potentially causing up to 85% of Social Security benefits to be included in taxable income. Qualifying private activity bond interest may also be included when AMT liability is calculated.
The return of after-tax pension or annuity contributions
When a retiree used after-tax money to contribute to a pension plan or annuity, the portion of later payments representing the return of those original contributions is generally not taxed again. The IRS generally refers to those after-tax contributions as the contract's investment in the contract.
For example, a person who contributed $50,000 to a pension plan using after-tax funds generally will not pay tax again on the portion of each pension payment that represents a return of that $50,000 principal. Amounts above the original contribution are generally included in income.
The taxable and tax-free portions are determined under IRS rules. The date payments began, along with the specific type of annuity or pension, can affect the calculation. Retirees should therefore not assume that an entire pension check is taxable simply because it comes from a traditional plan. Plan documents and tax forms can help identify after-tax contributions; a tax attorney or other qualified professional may be needed when the calculation is unclear.
At least part of Social Security benefits is not federally taxable
Up to 85% of Social Security benefits may be included in federal taxable income, which means at least 15% is not included. If a retiree's income is below the relevant thresholds, the benefits may be entirely exempt from federal income tax.
The IRS uses a measure known as combined income to determine the taxable portion. Combined income generally includes adjusted gross income, half of the Social Security benefits received and tax-exempt interest.
Under the 2026 thresholds, a single filer with combined income below $25,000 and a married couple filing jointly with combined income below $32,000 generally do not pay federal tax on Social Security benefits. For single filers with combined income between $25,000 and $34,000, and joint filers between $32,000 and $44,000, up to 50% of benefits may be taxable. Above those respective upper thresholds, up to 85% may be included in taxable income.
| Combined income | Single filer | Married filing jointly |
|---|---|---|
| Benefits generally not taxable | Below $25,000 | Below $32,000 |
| Up to 50% of benefits may be taxable | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% of benefits may be taxable | Above $34,000 | Above $44,000 |
Withdrawals from traditional IRAs or 401(k)s increase combined income and can therefore raise the taxable portion of Social Security benefits. Retirees planning withdrawals need to account for this interaction in their full-year tax calculations.
Federal tax treatment does not determine state tax
Federal and state tax rules for retirement income do not always align. Nine U.S. states do not impose a personal income tax, while other states may exempt Social Security benefits but tax some or all pension income, traditional IRA withdrawals, 401(k) distributions or other retirement-account income. Some states also offer deductions or exemptions for older taxpayers or for specific types or amounts of retirement income.
Retirees choosing where to live therefore need to look beyond whether a state levies an income tax. Property taxes, sales taxes, estate taxes, inheritance taxes and other state and local charges can also affect the overall cost of living. Comparisons should be based on an individual's actual mix of pensions, Social Security, investment income and account withdrawals rather than on a broad reputation that a state is retiree-friendly.
Plan the timing of withdrawals
Withdrawals from traditional IRAs and 401(k)s are generally taxable, while common sources such as interest, dividends and capital gains may also create tax liabilities. Before taking money out of an account, retirees should estimate total annual income and consider how a one-time investment sale, account withdrawal or other financial transaction could change the overall tax result.
When circumstances allow, spreading income across multiple tax years may be easier to manage than creating a large taxable-income spike in a single year. State rules remain relevant, especially when considering a move or comparing retirement locations. Each retiree's pension, Social Security, investment income and account withdrawals should be reviewed separately against the applicable federal and state rules.