Are RMDs Considered Earned Income for Tax Purposes?

Required Minimum Distributions (RMDs) from retirement accounts are not considered earned income for tax purposes. While these distributions are taxable, the Internal Revenue Service (IRS) classifies them differently from wages or self-employment profits. This distinction is important because it affects a retiree’s ability to contribute to other retirement accounts and can influence how other income, like Social Security, is taxed.

Defining Earned Income vs. RMDs

The IRS defines earned income as compensation received for services performed. This category includes wages, salaries, tips, commissions, and net earnings from self-employment. If you actively work for money, whether for an employer or for yourself, the payment you receive is considered earned income.

RMDs are withdrawals you must start taking from most tax-deferred retirement accounts, like traditional IRAs and 401(k)s, once you reach age 73. These distributions are taxed as ordinary income but are not earned income because they represent deferred compensation and investment gains, not payment for current work.

The core difference is the source: earned income comes from current work, while RMDs are withdrawals from past savings. This is why the IRS views them separately for tax purposes. The amount of your RMD is calculated by dividing your prior year-end account balance by a life expectancy factor from the IRS.

Impact on Retirement Contributions

To contribute to a traditional or Roth IRA, you must have earned income. The amount you can contribute is limited to your total earned income for the year, up to the annual maximum set by the IRS. Since RMDs do not qualify as earned income, they cannot be used to fund an IRA.

For example, if a retiree’s only income consists of $40,000 from RMDs and $25,000 from Social Security, they have zero earned income for the year. Consequently, they are ineligible to contribute to a traditional or Roth IRA. This rule prevents individuals from recycling their retirement distributions back into new tax-advantaged accounts.

An exception to this rule involves the spousal IRA. If one spouse is still working and has sufficient earned income, they may be able to make an IRA contribution on behalf of the non-working spouse. This allows a household to continue saving for retirement even if one partner’s income is solely from sources like RMDs and investments.

How RMDs Affect Social Security and Other Taxes

For individuals collecting Social Security before their full retirement age, there is an earnings limit. If earned income exceeds this annual limit, benefits may be temporarily reduced. Because RMDs are not earned income, they do not count toward this limit and will not cause a reduction in Social Security benefits.

However, RMDs can affect the taxability of your Social Security benefits. The IRS uses a “combined income” calculation to determine if your benefits are taxable. This figure includes your adjusted gross income, nontaxable interest, and half of your Social Security benefits. RMDs are part of your adjusted gross income and can increase your combined income, potentially triggering taxes on up to 85% of your benefits.

Because RMDs are not earned income, they cannot be used to qualify for certain tax credits. The Earned Income Tax Credit (EITC), for instance, is designed to assist low-to-moderate-income working families. Eligibility for the EITC is based on having earned income, so RMDs do not help a taxpayer qualify.

Failing to take the full RMD amount can result in a penalty of 25% of the amount not withdrawn. This may be reduced to 10% if the mistake is corrected in a timely manner.