The 3.8% Net Investment Income Tax: The Inflation Trap for Retirees
Episode 15
The 3.8% Net Investment Income Tax: The Inflation Trap for Retirees
Published on December 10th, 2025
Episode 15 of Retirement Tax Matters demystifies the 3.8% Net Investment Income Tax (NIIT), a surtax that is increasingly trapping high-net-worth retirees due to income thresholds ($200,000 for singles, $250,000 for married couples) that have not been adjusted for inflation since 2013. We explain the specific “Lesser of" calculation used by the IRS, illustrating how this tax applies to your dividends, interest, and capital gains once your Modified Adjusted Gross Income (MAGI) exceeds those fixed limits. The conversation highlights how common planning strategies, such as Roth conversions, can inadvertently trigger this surtax by driving your MAGI over the threshold, effectively creating an 18.8% capital gains rate. We also discuss how to weigh this tax against other friction points like Medicare IRMAA surcharges, arguing that while the NIIT should be minimized where possible, it shouldn't necessarily stop you from executing high-value planning moves. This is a practical guide to understanding if you are at risk of this inflation trap and how to incorporate it into your year-end tax projections.
Key Tax Planning Questions
Click Below To See The Answer
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For the most authoritative definitions, I always refer clients to this helpful IRS Q&A on the Net Investment Income Tax. Because tax laws involve many exceptions, you should always review your specific sources of income with your CPA or tax professional.
However, as a financial planner here is the general framework I wanted to provide to understand what typically falls into investment income subject to the 3.8% surtax and what stays out.
Generally Included (Subject to 3.8% Tax):
Interest & Dividends: From taxable brokerage accounts, savings, and CDs.
Capital Gains: Profits from selling stocks, bonds, mutual funds, and ETFs in taxable accounts.
Passive Income: Rental income and income from businesses where you do not actively participate.
Non-Qualified Annuities: The taxable portion of payments from annuities purchased outside of retirement plans.
Generally Excluded (NOT Subject to 3.8% Tax):
IRA & 401(k) Distributions: Taxable withdrawals from traditional retirement plans.
Roth Conversions: The converted amount itself is not subject to the surtax.
Social Security Benefits: These are generally exempt.
Wages & Self-Employment Income: Money earned from working.
Home Sale Gains (up to limits): The standard exclusion amount ($250k single/$500k married) on the sale of a primary residence is typically exempt. (Note: Any gain above these limits is considered investment income and is subject to the tax.)
A Planning Note on the MAGI Trap: It is important to remember that while IRA withdrawals and Roth conversions are not directly taxed at 3.8%, they do increase your Modified Adjusted Gross Income (MAGI). Since the NIIT is triggered when your MAGI exceeds the income thresholds ($200k/$250k), a large Roth conversion can cause your other investment income (like dividends and capital gains) into the taxable zone. This interaction is why we always coordinate with your tax professional before executing year-end moves.
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The short answer is no.
The Net Investment Income Tax (NIIT) went into effect on January 1, 2013, to levy an additional 3.8% surtax on investment income for high earners. The thresholds established in 2013 remain exactly the same today:
$250,000 for Married Couples Filing Jointly
$200,000 for Single / Head of Household
$125,000 for Married Filing Separately
The Inflation Trap is the critical issue that unlike tax brackets or standard deductions, these thresholds are not indexed for inflation. A fixed $250,000 limit in 2013 is not the same as $250,000 in 2026!
Because this NIIT surtax ignores inflation, every year more HNW retirees are stumbling into this additional surtax.Strategic Takeaway: Once your Modified Adjusted Gross Income (MAGI) surpasses these limits, the 3.8% surtax applies to the lesser of your net investment income or the amount over the threshold. While no one enjoys paying an extra tax, don't always let the tax tail wag the dog.
In scenarios like a strategic Roth Conversion or diversifying a highly concentrated stock position, it often makes financial sense to pay the 3.8% surtax today to secure tax-free growth for the future or to reduce significant portfolio risk. Every household is different, but sometimes the long-term benefit outweighs the short-term cost.
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For retirees in the $2M–$8M net worth range, this is a frequent scenario that highlights why tax planning provides such significant value.
You are describing a common objective: You want to fill up a favorable tax bracket (such as the 22% or 24% bracket) with a strategic Roth conversion. However, you are right to be concerned about the interaction between different taxes and penalties as your income increases.
The Interaction Between NIIT and IRMAA When you convert Traditional IRA funds to Roth, you are adding ordinary income to your tax return. This raises your total Modified Adjusted Gross Income (MAGI), which effectively pushes your investment income over the limit. This increase in income impacts two separate thresholds simultaneously:
The NIIT Threshold: If the conversion pushes your total MAGI over $200,000 (single) or $250,000 (married), your investment income becomes subject to the 3.8% NIIT surtax.
The IRMAA Brackets: That same increase in MAGI may push you into a higher Medicare income bracket, triggering increased premiums for Part B and Part D two years from now.
Tax Planning Software Calculating this interplay by hand is difficult because you are balancing three different schedules at once. We use specialized tax software to model these specific scenarios.
The output graphics from the tax planning software often reveal a clear sweet spot—a precise conversion amount where we can maximize the 24% ordinary income bracket and stay just under a harsh IRMAA cliff. In these cases, we might accept paying a small amount of NIIT because we are successfully optimizing the other two major variables. Seeing the math laid out visually gives you the confidence that you are getting the optimal blend of tax-free growth and bracket management, rather than flying blind into a surcharge.
If you are asking this question, you are likely a thoughtful and discerning retiree who understands that tax planning is about more than just the marginal bracket. Quantifying the total cost of a conversion—including NIIT and IRMAA—is the only way to ensure the long-term benefit of tax-free growth outweighs the short-term costs.
Full Episode Transcript
Adam: Good morning and welcome to Retirement Tax Matters. I'm Adam Reed, and this is Garrett Crawford, our Certified Financial Planner (CFP) in the office. We're excited to bring you another episode. How many episodes in are we?
Garrett: I think this is number 15. We took last week off—I'm sure everybody missed us for Thanksgiving—but I had a good Thanksgiving. I know you did too. I got to take my son to a Titans game in Nashville for the first time. My parents had bought us a small birthday/Christmas present, so it was a good Thanksgiving, a great way to cap it off. Work in December, as a financial planner who focuses on tax planning, got back into it quickly. Today is Thursday when we record these, and it was zero to a hundred on Monday. We had all kinds of things going on, and I look forward to this topic today.
Adam: I think it's an applicable subject, and something that people may have heard of. I feel like a lot of people say, "Oh yeah, I've heard of that." But what it actually is and how it works can be confusing. It's like a word you use a lot, and when someone asks you to define it, you struggle. So, hopefully, today we can bring some definition to this, walk people through what it is, how it works, and maybe how to avoid or minimize it. We'll also cover when it's a problem and when it's not. I don't want to bury the lead here, but today we're talking about the Net Investment Income Tax (NIIT). I'm really excited about this one.
Garrett: Me too. It's a big topic.
Adam: To kick us off: The Net Investment Income Tax is a 3.8% surtax. What is this, and why does it seem to be popping up more and more for retirees as we're doing planning?
Garrett: That's a great question. It's December, and one of the reasons I wanted to talk about this is because it has popped up an abnormal amount of times this year as I've been reading through tax returns and discussing Roth conversions. Anytime I see something continue to pop up in real life, I think it's great material for a podcast, especially when many of our clients have questions. The niche of this podcast is probably someone who is retired or getting close to retiring, and they're in that bracket of maybe one to two million, or even up to eight million dollars—what we would call a high-net-worth retiree. When people are in those windows, there is a high correlation that they will have high income. High income doesn't just mean you have a lot of money; there is a high correlation. The Net Investment Income Tax is something I feel like people are pretty unfamiliar with. When I bring it up, they usually ask, "What's that? How does that work?" I want to demystify that today. It is an additional surcharge on investment income. When we talk about investment income, it can be dividends, interest, and capital gains. Usually, that is going to come from your investment accounts, like a joint brokerage account with a spouse, or an individual brokerage account. The NIIT does not apply to money inside your traditional IRA or your Roth IRA, but it will apply to your brokerage accounts—what we would call a taxable account. I have the numbers here in front of me, and there's no point in memorizing all of this, but the level at which the 3.8% surcharge applies is based on your tax filing status. For many people, that will be married filing jointly or single. The difference in the rates is usually double, but in this case, they are a lot closer. The big number to remember for married filing jointly is that the Net Investment Income Tax becomes relevant at $250,000 of income. If you are a single person, that number is $200,000. The other filing status, head of household, is also $200,000. Married filing separately is a little trickier at $125,000 per person, so you get a little penalty there. I want to talk a little bit about how it's calculated. It's a little tricky, but there is a formula I remember from my CFP study. It's based on your Modified Adjusted Gross Income (MAGI). For many people listening, we add up your taxable 401(k) distributions, your pension, your investments—really, everything that you have coming into your bank account, or even dividends paid out to your investment account. If you are married filing jointly, and when we add all those numbers up, it goes over $250,000, we have to apply the Net Investment Income Tax formula. That formula looks at the difference between your taxable income and $250,000, or it looks specifically at your investment income. We would add up all your dividends, interest, and capital gains. I have a couple of examples we might be able to share here in a little bit. If your MAGI as a married person was $300,000, that would be $50,000 over the limit. But let's say you only had $30,000 of investment income or capital gains. The Net Investment Income Tax looks at the lesser of those two. In that example, the $30,000 of investment income would be the amount taxed at 3.8%. I think that's probably a good place to stop right there, but it is an additional penalty that you pay if you're married filing jointly and your income goes over $250,000.
Adam: That's a lot of numbers and a lot of moving parts. Do we have a real-world example of how that calculation works—this "lesser of" concept—to help somebody see how they could plug in their income and think through it that way?
Garrett: Sure. Let's use an example of an individual person, not a married person, so it will come back to that lower limit of $200,000. I wrote this down, so I'm just going to read it. Let's talk about Sarah, an individual person. Her income from Social Security and a pension is $150,000. She decides to sell some stock for a $100,000 profit. We take the base income, which was $150,000, and add the $100,000 on top of that. Now her total income is $250,000, which is $50,000 above the $200,000 limit. So, even though she had $100,000 of investment gain, she only pays the 3.8% Net Investment Tax on the $50,000 that put her over the top of the $200,000 limit. The "lesser of" feature of the NIIT form saves her from paying it on the full $100,000 of her capital gain. I would back up a little bit here and say this podcast isn't necessarily about teaching you how to do the NIIT calculation. Instead, it is far more relevant for high-net-worth people to know that this is on the radar when you have a taxable brokerage account with highly appreciated stock that is generating a lot of taxable dividends or capital gains that puts you over that $250,000 mark. One of the epiphany moments I've had over the past couple of weeks as I've been thinking about this—and it was kind of cool as I was doing my research this morning—I was reminded that this $200,000 limit for an individual person, or a $250,000 income threshold for a married couple, was last set and enacted in 2010, effective in 2013, and it has not been adjusted for inflation since. I did a little math this morning, and there has been about 37% of cumulative inflation since 2013 that has not been implemented on this Net Investment Income Tax. Whereas in 2013, $250,000 was a lot of money and truly was a high-income situation. If it had been adjusted for inflation all the way to 2025, that number would be more like $343,000. The moral of this NIIT conversation is that because it's not adjusted for inflation each year, I'm seeing more and more clients be impacted by their income increasing over the $250,000 threshold. This is causing what they used to consider a long-term capital gain taxed at 15% to now be tagged with an additional 3.8% penalty. When we are doing estimated taxes or figuring out what the taxes are going to be, we are having to factor in an 18.8% capital gains tax. That is still better than these clients' ordinary income rates, which are like 22%, 24%, 32%, or 35%. It's still better, but it's an unexpected tax. I am in the business of trying to prevent tax surprises for people come tax filing time, and that is one that I think there's some financial planning you can do to be aware of.
Adam: That's a good segue. I like what you said: Our goal is not to make you an expert at the Net Investment Income Tax, but one of the things we love to do is tax-return-driven financial planning and in-year tax projections. It may surprise you that neither of our children are named Roth, but we love Roth conversions around here; it's a great tool to have in the tool belt. Maybe touch on, in light of that, how we should think of the Net Investment Income Tax as we are looking to do a Roth conversion, or do some of those in-year tax-return-driven financial planning moves at the end of the year, whether people are doing it themselves or looking for an advisor who thinks through these things.
Garrett: I could go a lot of different ways with that, but I would start with this: Financial planning in 2025—tax planning in 2025—is not simple. I say you don't have to know exactly how the Net Investment Income Tax is calculated and when it applies. I use tax planning software to figure that out, and I'm often reminded by the software when it comes into play and how to avoid it. But we have a confluence of complicated factors that I think really brings value to what we are doing, or even our listeners who don't work with an advisor. It complicates the decision of when to do Roth conversions and when to consider the Net Investment Income Tax. I would explain it like this: A $50,000 or $100,000 Roth conversion is going to raise your Modified Adjusted Gross Income (MAGI), which can trigger the NIIT. Selling highly appreciated stock at long-term capital gains rates is also going to increase your income, which could trigger the Net Investment Income Tax. If you do too many Roth conversions, you might also bump your head up against the Medicare IRMAA surcharge, where you have to start paying more for your Medicare premiums. Also, you probably don't want to do too much long-term capital gain or Roth conversion if it puts you into another tax bracket, like jumping from 24% to 32%—that is a jump you don't want to make. I don't know any other way, and I recently discovered this two years ago, but it's really the impetus for everything that we're doing: How is the average retiree supposed to be able to think through, just for starters, thinking ahead in September for what their income is going to be in December? That's the biggest missing ingredient. We have a podcast about that, but that's hard enough. It's another step for retirees to be able to navigate: When to do Roth conversions without triggering too many Medicare charges. How much long-term capital gain to sell, which takes the place of some of the Roth conversion abilities you have. And then this new thing we are talking about here, the Net Investment Income Tax: What if we trigger too much and have to sell at 18.8% taxes? My thinking is this: Unless you're really, really good, you're going to need some type of software or work with somebody that really knows what they're doing, or a tax preparer who has time to work with you to navigate all that. As a general rule, operating in my mind when I'm working with people, I'm not here to avoid taxes at all costs. The Net Investment Income Tax is 3.8%. "Let's cut off your income. Don't sell any more." Generally speaking, when I see the NIIT, I'm not that scared of it. 3.8% for somebody who needs to sell $50,000 to give a gift to somebody, maybe pay for a vacation, or pay off a mortgage—you don't want to miss the forest for the trees. Don't stop doing something that is important in your life because you're afraid of a 3.8% surcharge tax on long-term capital gains rates. I interact with a lot of people who hate taxes so much that it really does come into mind. They're like, "I don't want to hit that Net Investment Income Tax; let's just stay right below and keep it at the 15% rate." Oftentimes, my job is to help clients push through when it makes sense to trigger an IRMAA charge for Medicare or when it makes sense to push through an additional 3.8% Net Investment Income Tax. It's going to be really different for a lot of people where you land. But I would say what you don't want to happen is, let's pretend you're in December and you could have waited two or three weeks and submitted that $50,000 long-term capital gain sale on January 1st instead of December 4th, and that would have saved you an additional 3.8%. So, I'm not saying disregard taxes or disregard Medicare charges. But I am saying this exercise is really helpful for people to do so that you don't do something silly, which is trigger a huge Medicare premium by just going barely past the dollar amount. You might not want to do a big long-term capital gain/NIIT sale when you could defer that three weeks into the new year.
Adam: That's a good place to land: The Net Investment Income Tax shouldn't drive the bus, but it's a passenger on the bus, and we should be aware of it. It's something to be mindful of. 3.8% is, in my head, about $1,900 if you did $50,000. It's not the end of the world, but it's something. Like you said, planning, especially around the end of the year and the beginning of the year, clustering things to make sure you're doing them in an optimal way. I think having software, a formula, a method that you trust, or a financial advisor you trust who can help you walk through those things is super crucial. It is so funny that every year there feels like there's another threshold, another thing to be careful about.
Garrett: You are going to bump your head on some of these things. They are there to raise revenue for our country, which is not even a bad thing—our country needs money to run. It's just that we don't want to be silly and barely trigger these things when they were avoidable if you just known the parameters in advance. That's really the goal.
Adam: Absolutely. Well, good deal. Thank you all for tagging along today on Net Investment Income Tax. Welcome back from Thanksgiving. It's a sprint to Christmas. It flies by. I have young kids, too, so it's like every day, "22 days, seven hours," even though they can't even count yet.
Garrett: And I guess the more I'm involved in this, there's Christmas, but then there's December 31st. That's the day we have to get all our stuff in for our clients. So I've got two big days: the 25th and the 31st.
Adam: The deadlines are coming. The deadlines are coming. Well, good deal. Thank you all for tagging along with us today. Like, subscribe, and follow here on YouTube. Check us out on Spotify, Apple Music, Apple Podcasts—all the different places we post. And check out the website, RetirementTaxMatters.com. I think it's a good resource. It has all our podcast episodes and some free resources, maybe a little checklist if you're heading into retirement or if you just retired, trying to make sure you kind of have your ducks in a row. Check it out there.
Garrett: I'd say too, for anyone who listens this long, I write a newsletter every week. It's kind of cool—I take the conversations that we were talking about today and I just add a more personal anecdote. I think that's a wonderful way. If you find value in the podcast, the weekly newsletters are short, brief, but add an extra little layer. Adam, it was fun doing this today, and I look forward to doing it again.
Adam: Glad to be back. I'm Adam Reed.
Garrett: Garrett Crawford.
Adam: Retirement Tax Matters.