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One of the last things you want to worry about in retirement is taxes. However, since taxes affect how much hard-earned money you keep, a key area, sometimes overlooked by retirees, deserves some attention: capital gains tax.
Maybe youre considering selling a stock youve held for many years or downsizing your longtime family home. Though seemingly straightforward for some, these kinds of decisions can have significant tax implications.
In addition to the personal and potentially emotional aspects of those and similar financial moves, capital gains tax can help preserve or unexpectedly reduce your retirement nest egg. Here’s more of what you need to know.
The Quick Answer: Capital Gains and Social Security
When figuring out your Social Security benefit, capital gains don’t count as “earned income.” This means that the money you make from selling investments won’t make your benefit bigger or smaller because of earnings limits.
However, capital gains do count as income for tax purposes, which may indirectly affect your Social Security by potentially causing a portion of your benefits to become taxable
How Capital Gains Impact Social Security: The Complete Picture
If you’re approaching retirement or already collecting Social Security, you might wonder if selling stocks, real estate, or other investments might affect your benefits. The relationship between capital gains and Social Security is actually pretty nuanced.
Capital Gains Don’t Affect Your Benefit Amount
Good news! Capital gains don’t directly impact your Social Security benefit amount. Whether you make $1,000 or $100,000 in capital gains:
- It won’t increase your future Social Security benefits
- It won’t reduce your current benefits due to earnings limits
- You don’t pay Social Security (FICA) taxes on capital gains
Social Security only considers earnings from work (wages or self-employment income) when:
- Calculating your initial benefit amount
- Determining if you’ve exceeded the earnings limit for early retirees
- Earning credits toward eligibility
But Capital Gains Can Affect Taxation of Your Benefits
Here’s where things get tricky. Capital gains don’t change how much Social Security you get, but they can change how much you get to keep after taxes:
- The IRS uses “combined income” to determine if your Social Security benefits are taxable
- Combined income = Adjusted Gross Income (AGI) + Nontaxable interest + Half of your Social Security benefits
- Capital gains are part of your AGI
If your combined income exceeds certain thresholds, a portion of your benefits becomes taxable:
| Filing Status | Combined Income | Taxable Portion of SS Benefits |
|---|---|---|
| Single | $25,000 – $34,000 | Up to 50% |
| Single | Over $34,000 | Up to 85% |
| Married Filing Jointly | $32,000 – $44,000 | Up to 50% |
| Married Filing Jointly | Over $44,000 | Up to 85% |
Real-Life Example
Let’s say you’re married filing jointly with:
- $50,000 in gross income (including some capital gains)
- $36,000 in annual Social Security benefits
That’s $68,000 if you add up your gross income and half of your benefits. Because of this, up to 85% of your Social Security benefits ($30,600) would be taxed by the federal government since this is more than $44,000.
Common Misconceptions About Capital Gains and Social Security
People often make these mistakes when thinking about capital gains and Social Security:
Myth #1: Any Income Reduces Your Social Security Check
A lot of people are afraid that investment income, like capital gains, will cut their Social Security benefits. This isn’t true! Before full retirement age, Social Security benefits will only go down if you have earned more than a certain amount. Investment income, such as capital gains, does not count toward these limits on earnings.
Myth #2: Capital Gains Boost Your Future Social Security Benefits
Some investors hope that reporting big capital gains will lead to higher Social Security benefits later. In reality, only wages or self-employment income on which you paid Social Security taxes count toward your benefit calculation. Your $50,000 profit from selling property won’t increase your future Social Security checks.
Myth #3: Ignoring the Tax Impact on Your Benefits
While capital gains won’t reduce your gross Social Security benefit, failing to plan for the tax impact is a common mistake. Big capital gains can push your income over the thresholds that make Social Security benefits taxable. To avoid surprises, consider strategies like spreading sales over multiple years.
The Earnings Test: What Actually Counts?
If you claim Social Security before reaching Full Retirement Age (FRA), there’s an earnings test that can temporarily reduce your benefits. For 2024:
- If you’re under FRA all year: You can earn up to $21,240 from work with no benefit reduction
- In the year you reach FRA: The limit is higher at $56,520
- After reaching FRA: No earnings limit applies at all
Important: This earnings test ONLY applies to earned income from work. Capital gains and other investment income don’t count against these limits.
Beyond Federal: State Taxation Considerations
While we’ve focused on federal rules, state taxation of Social Security varies widely:
- States that don’t tax Social Security benefits at all: Most states (38 plus DC) either have no income tax or fully exempt Social Security benefits from taxation
- States with partial taxation: About 12 states tax Social Security benefits for higher-income retirees or offer credits/deductions
If you live in a state that taxes Social Security based on your income level, capital gains could push you into taxable territory for state taxes on your benefits.
Medicare Considerations (IRMAA)
Here’s something many retirees don’t realize: Capital gains can affect your Medicare premiums through Income-Related Monthly Adjustment Amount (IRMAA). A big one-time stock sale could bump you into a higher income bracket and lead to higher Medicare premiums two years later.
Smart Strategies to Manage Capital Gains and Social Security
Here are some approaches to consider:
- Spread out capital gains across multiple tax years to avoid large income spikes
- Harvest losses to offset gains when possible
- Consider timing – realize gains in years when your other income is lower
- Use tax-advantaged accounts like Roth IRAs where withdrawals don’t count in the combined income formula
- Consult with a tax professional to develop a strategy tailored to your situation
Key Terms Explained
Understanding the terminology helps navigate these complex rules:
- Earned Income: Money from working (wages, salary, self-employment)
- Unearned Income: Investment income like capital gains, interest, dividends
- Combined Income: Special calculation used by IRS to determine if your Social Security is taxable
- Full Retirement Age (FRA): Age when you qualify for full benefits (66-67 for most people)
FAQs About Capital Gains and Social Security
Do I pay Social Security tax on capital gains?
No. Capital gains are not subject to Social Security (FICA) payroll taxes.
Will capital gains reduce my Social Security retirement benefits?
No. Capital gains have no effect on your Social Security benefit amount.
Can a large capital gain make my Social Security benefits taxable?
Yes. A big capital gain can raise your total income above IRS thresholds, causing up to 85% of your Social Security benefits to become taxable income.
Do I need to report capital gains to the Social Security Administration?
No. You report capital gains on your tax return to the IRS. You don’t need to report them to Social Security.
Will selling my house increase my Social Security benefits?
No. Selling assets for a gain won’t increase your Social Security benefits, which are based only on work earnings.
Final Thoughts
The relationship between capital gains and Social Security has important nuances. While your capital gains won’t affect your benefit amount or trigger the earnings test, they can significantly impact how much of your Social Security is taxed.
By understanding these rules and planning carefully, you can make smarter decisions about when and how to realize capital gains during your retirement years. This might save you thousands in taxes and help your retirement funds last longer!
Remember, it’s always a good idea to consult with a financial advisor or tax professional about your specific situation, especially when making decisions about large capital gains that could affect your Social Security taxation.
Required minimum distributions (RMDs)
RMDs from traditional retirement accounts add another layer of complexity to capital gains planning. That’s because required minimum distributions are taxed as ordinary income and can push retirees into higher tax brackets. (RMDs are generally required once retirees reach age 73. ).
To help mitigate this, you might consider strategies like:
- Spread out the tax impact by taking capital gains in years with lower RMDs.
- Using Qualified Charitable Distributions (QCDs) to meet RMD requirements without making more money taxable
- Exploring Roth conversions in lower-income years to reduce future RMDs
Capital gains considerations in retirement
Tax rates, Social Security benefits, Medicare premiums, required minimum distributions (RMDs), and home sales are just a few of the things that can affect capital gains. (There are also state capital gains taxes to think about. ).
So, appreciating the connections can help you optimize your retirement tax strategies. Lets consider each of these areas.
For some retirees, the federal income tax rate goes down, which can be helpful when it comes to capital gains.
Though, it’s important to note that retiring in a lower tax bracket might not happen as often as you think. In retirement, some people will end up in the same or a higher tax bracket because they have multiple sources of income, fewer tax deductions, big withdrawals from retirement accounts that were set up before taxes, and other things.
If you are a retiree in a lower tax bracket than when you were working, you may benefit from those favorable tax brackets while realizing long-term capital gains.
- People who file as a single person and make up to $47,025 a year can realize long-term capital gains at a 20% rate for 2024.
- When married couples file their taxes together, they can get tax breaks of up to $94 050 of their taxable income.
- Because retirees are in a lower tax bracket, they may be able to sell assets that have gone up in value while still paying as little tax as possible.
Timing asset sales strategically helps you take advantage of retirement years with lower income and realize gains at preferential rates.