Unearned Income: Definition, Meaning & Example

KEY TAKEAWAYS

• Unearned income is income that isn’t made through business activities or via work. 
• Examples of unearned income include interest, inheritance, or dividends earned from investments. 
• Different tax rates are levied on unearned income when compared to earned income. 
• Unearned income can serve as supplemental income to your ordinary earned income. 
• When you are retired, unearned income is often the only source of income.

What Is Unearned Income?

Unearned income is any income that you receive that was not acquired through work. Examples of unearned income include bond interest, alimony, stock dividends, and interest from savings accounts.

Unearned income is also known as passive income. 

Types of Unearned Income

The most typical forms of unearned income are interest and dividend income. When money is obtained in this way, it is termed unearned income and is subject to unearned income taxation.

Other types of unearned income include:

• Gifts
• Retirement accounts such as pensions, annuities, and 401(k)s
• Alimony
• Inheritance
• Lottery winnings
• Social Security benefits
• Welfare benefits
• Property income
• Unemployment compensation
• Veterans Affairs benefits

Benefits of Unearned Income

There are many benefits of having access to passive income. 

Before retirement, earned income can be supplemented with unearned income; during the post-retirement years, it is frequently the only source of income. For many forms of unearned income, taxes are postponed throughout the accumulation phase.

401(k) plans and annuity income are examples of unearned income sources that permit the deferral of income taxes.

Participants avoid IRS fines and increased tax rates as a result.

Example of Unearned Income

Let’s say that Investor X makes a $5,000 investment. The interest that they get from their investment would be considered unearned income. It therefore must be reported to the Internal Revenue Service (IRS) for taxation at the normal income rate.

Summary

Unearned income is any federal income that comes to you passively, meaning you don’t have to work to earn it. 

It is a good idea to make investments throughout your working life so that you can enjoy the benefits of having passive income when you are in your retirement years.

Written by Jami Gong, MPAcc, CPA

Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.

Written by Jami Gong, MPAcc, CPA

Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.