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Options may be either grants from your employer or contracts you purchased on the market. If you are receiving Social Security benefits when you exercise the options to buy or sell shares of stock, it may affect your benefits. The relevant rules are set by the Social Security Administration and the Internal Revenue Service. The impact on your benefits, if any, depends on your age, income and the type of options you exercise.
Social Security Rules
Income can affect the amount of your Social Security when you choose to start benefits before you reach full retirement age, which was 66 as of 2013. You can start benefits as early as the month you turn 62. The Social Security Administration only counts income that is compensation for work. Income from other sources, such as investments, interest or pensions, does not affect your benefit amount. Once you reach full retirement age, other income does not affect the size of your benefit check, regardless of its source.
Options Profits as Capital Gains
When you exercise stock options that you bought on the market, any profits you make are considered capital gains. As such, these profits are not considered compensation from working and so do not affect the amount of your Social Security benefits. Profits you earn from employer-granted incentive stock options are also considered capital gains provided the exercise takes place at least a year after you were granted the options and you hold the stock for an additional year.
The exercise of a second type of options, non-qualified employee stock options, may affect the amount of Social Security benefits you receive before you reach full retirement age. The difference between the exercise price you pay for the stock and the market price of the shares on the day of exercise is considered compensation and is included in your earnings on your W-2 form. Consequently, the Social Security Administration counts this as work income. As of 2013, if you are receiving retirement benefits before your full retirement age and your work income exceeds a limit of $15,120 in the calendar year your benefits are reduced by $1 for every $2 over the limit.
The IRS does not consider Social Security benefits taxable as long as your income does not exceed certain limits. The exercise of stock options can affect your benefits by making them taxable if profits from the exercise push your income over these limits. To see if this is the case, add 50 percent of your annual benefit amount to your adjusted gross income, including the options income. If you file as single and the total exceeds $25,000, some of your benefits are taxable. If you are married and file a joint return, the limit is $32,000.