Does Passive Income Affect Social Security Benefits?

Social Security benefits are a significant income source for many Americans in retirement. Understanding the distinction between earned and passive income is important for those receiving or planning to receive Social Security, as different income types can influence these benefits.

Distinguishing Income for Social Security

For Social Security purposes, income is primarily categorized into two types: earned income and passive income. Earned income refers to money received from work, such as wages, salaries, commissions, bonuses, vacation pay, and severance pay. It also includes net earnings from self-employment, which is the profit an individual makes from a trade or business after deducting allowable expenses. These types of income are directly tied to an individual’s active participation in a job or business.

Passive income, in contrast, is generally derived from sources where the individual is not actively working or materially participating. Common examples include dividends and interest from investments, capital gains from selling assets not part of a trade or business, and rental income from properties where the owner is not significantly involved in day-to-day management. Pensions, annuities, and distributions from retirement accounts like 401(k)s and IRAs are also considered passive income.

How Passive Income Interacts with Benefits

Passive income generally does not affect the amount of Social Security retirement or spousal benefits an individual receives. The Social Security Administration (SSA) primarily focuses on whether a beneficiary is still engaged in work and earning income from employment or self-employment.

Similarly, rental income from properties where the recipient is not materially participating in management is usually classified as passive income and does not impact benefit amounts. Income from pensions and annuities also falls into this category, as these are considered non-work-related sources of funds. Therefore, individuals can typically receive these types of income without their Social Security benefits being reduced.

Earned Income and Benefit Reductions

While passive income typically does not affect Social Security benefits, earned income can lead to a temporary reduction through the Retirement Earnings Test (RET). This test applies to beneficiaries who are below their full retirement age (FRA) and continue to work. Full retirement age varies based on birth year, ranging from 66 to 67 for those born in 1960 or later. Once a beneficiary reaches their FRA, the RET no longer applies, and earned income does not reduce benefits.

For individuals who are under their full retirement age for the entire year, Social Security will deduct $1 from benefits for every $2 earned above an annual limit. In 2025, this limit is $23,400. For example, if someone earns $25,400 in 2025 and is under their FRA all year, the $2,000 earned over the limit would result in a $1,000 reduction in benefits.

A different rule applies in the year a person reaches their full retirement age. For the months leading up to their FRA, Social Security will deduct $1 from benefits for every $3 earned above a higher annual limit. In 2025, this limit is $62,160. Earnings in or after the month a person reaches their FRA do not count toward this earnings test. Any benefits withheld due to the RET are not permanently lost; they result in a higher monthly benefit amount once the individual reaches full retirement age.

Important Reporting and Specific Situations

Self-employed individuals must report their net earnings from self-employment to the Social Security Administration (SSA) if their net earnings are $400 or more in a year. These net earnings, calculated after deducting business expenses, are considered earned income and are subject to the Retirement Earnings Test if the individual is below their full retirement age. Self-employed individuals are responsible for paying both the employer and employee portions of Social Security and Medicare taxes.

The distinction between passive and earned income can sometimes be nuanced, particularly with rental activities. While most rental income is considered passive, if an individual provides substantial services to tenants, such as operating a hotel or providing services beyond basic property management, the income could be reclassified as earned income from a trade or business. This reclassification would then subject that income to the Retirement Earnings Test. Therefore, accurate reporting of income to the SSA is important, especially for those below full retirement age.

While passive income generally does not reduce Social Security benefits, the benefits themselves can become taxable income if a recipient’s total combined income exceeds certain thresholds. For 2025, if a single filer’s combined income is between $25,000 and $34,000, up to 50% of their Social Security benefits may be taxable. If combined income exceeds $34,000 for single filers, or $44,000 for married couples filing jointly, up to 85% of benefits may be taxable. This is a separate income tax consideration and does not involve a reduction in the Social Security benefit amount paid by the SSA.