Does Passive Income Count Against Social Security?
Understand how different income types, including passive earnings, interact with Social Security benefits. Get clarity on what counts.
Social Security benefits provide financial support for retirement, disability, and survivorship. Many beneficiaries wonder if income typically considered “passive” could reduce their Social Security benefits. Understanding the Social Security Administration’s (SSA) income distinctions helps individuals plan their financial strategies.
Defining Passive Income for Social Security
In general finance, passive income refers to earnings from an enterprise where an individual is not actively involved. This often includes investment income (dividends, interest), rental income with minimal owner involvement, and royalties. This definition helps differentiate it from actively earned wages or self-employment income.
For Social Security purposes, income is primarily distinguished as “earned” or “unearned.” Earned income includes wages from employment and net self-employment earnings, subject to Social Security taxes. Unearned income covers other sources not resulting from active work. The SSA uses this classification to determine how income affects benefit payments.
Income sources commonly considered passive, such as investment income from stocks and bonds, are generally classified as unearned by the SSA. Rental income is also typically unearned, unless the beneficiary is a real estate professional materially participating in the business. This classification determines the impact on Social Security benefits.
How Social Security Benefits are Affected by Earnings
Social Security benefits can be reduced by the Social Security Earnings Test if a beneficiary earns income above certain limits. This test applies to individuals receiving benefits who have not yet reached their full retirement age (FRA), which varies from 66 to 67 years. Once FRA is reached, the earnings test no longer applies, and benefits are not reduced regardless of earnings.
For beneficiaries below FRA for the entire year, an annual earnings limit applies. If earned income exceeds this limit, the SSA withholds $1 in benefits for every $2 earned above the threshold. In the year FRA is reached, a higher earnings limit applies to income earned before FRA. For income above this higher limit, the SSA withholds $1 for every $3 earned.
The earnings test ensures Social Security benefits primarily support those fully retired or transitioning into retirement. Any benefits withheld due to the earnings test are not permanently lost. The SSA recalculates the individual’s benefit amount at their full retirement age, crediting them for the months benefits were withheld. This adjustment generally results in a higher monthly benefit amount in the future.
Income Included and Excluded from the Earnings Test
The Social Security Earnings Test specifically considers “earned income” for potential benefit reductions. This category primarily includes wages from an employer and net earnings from self-employment activities. For self-employed individuals, net earnings are calculated after deducting allowable business expenses. These earnings can trigger a reduction in Social Security benefits if they exceed the annual limits.
Conversely, a wide range of income sources are explicitly excluded from the Social Security Earnings Test and do not impact benefit payments. Investment income, such as dividends from stocks, interest from bonds, and capital gains from selling assets, is not counted. These forms of income are generally considered passive and are not tied to active work. This means individuals can typically receive substantial income from their investment portfolios without affecting their Social Security benefits.
Rental income is also generally excluded from the earnings test, provided the beneficiary is not materially participating in the rental property business as a real estate professional. If significant services are provided to tenants, beyond typical landlord duties, the income may be reclassified as self-employment earnings and thus subject to the test. Other excluded income types include pensions, annuities, and withdrawals from retirement accounts like IRAs and 401(k)s. Government or military retirement benefits, gifts, and inheritances also do not count against Social Security benefits.