Can your 401 (k) plan affect your Social Security benefits?

The income you receive from your 401 (k) or other qualified retirement plan does not affect the amount of Social Security retirement benefits you receive each month. However, you may have to pay taxes on some or all of your benefits if your annual income exceeds a certain threshold, and your 401 (k) distributions may cause you to do so.

Key takeaways

  • Income from Social Security retirement benefits does not change based on other retirement income, such as from 401 (k) plan funds.
  • Social Security income, on the other hand, is calculated based on your lifetime income and the age at which you choose to begin receiving Social Security benefits.
  • However, distributions from a 401 (k) can increase your total annual income to the point where your Social Security income will be taxable.

Why doesn’t 401 (k) income affect Social Security?

Your Social Security benefits are determined by the amount of money you earned during your working years, years in which you paid into the system through Social Security taxes. Since contributions to your 401 (k) are made from compensation received from employment from a US business, you have already paid Social Security taxes on those dollars.

But wait, weren’t your contributions to your 401 (k) made with pre-tax dollars? Yes, but this tax shelter feature only applies to federal and state income tax, not Social Security. You still pay Social Security taxes on the full amount of your compensation, up to a predetermined annual limit set by the IRS, in the year you earned it. This limit is generally increased annually and is currently capped at $ 142,800 for 2021.

“Contributions to a 401 (k) plan are subject to Social Security and Medicare taxes, but are not subject to income tax unless you are making a Roth contribution (after tax),” says Mark Hebner, founder and President of Index Fund Advisors Inc. in Irvine, California, and author of Index Funds – The 12-Step Recovery Program for Active Investors.

Simply put, this is why you owe income taxes on 401 (k) distributions when you take them, but not Social Security taxes. And the amount of your Social Security benefit is not affected by your taxable 401 (k) income.

The Tax Impact of 401 (k) Savings

Once you begin receiving distributions from your 401 (k) or another retirement savings plan, such as an IRA, you will not owe Social Security taxes on the distribution for the reason described above; paid his dues during his working years. But you may have to pay income taxes on some of your benefits if your combined annual income exceeds a certain amount.

Income thresholds are based on your “combined income”, which is equal to the sum of your adjusted gross income (AGI), which includes earned wages, withdrawals from any retirement savings accounts (such as IRA and 401 (k) , any -taxed interest and half of your Social Security benefits). If you take large distributions from your traditional 401 (k) in a given year in which you receive benefits, and remember, you should start taking them from all 401 (k) once you turn 72, you are more likely to exceed the threshold of income and increase your tax liability for the year.

According to the Social Security Administration, for 2020, if your total income for the year is less than $ 25,000 and you are filing as an individual, you will not be asked to Paying taxes anywhere on your Social Security benefits. If you file a joint return as a married couple, this limit rises to $ 32,000.

You may be taxed on up to 50% of your benefits if you are an individual with income between $ 25,000 and $ 34,000, or if you file a joint return and have income between $ 32,000 and $ 44,000. Up to 85% of your benefits may be taxable if you are single and earn more than $ 34,000 or if you are married and earn more than $ 44,000.

Other Factors Affecting Social Security Benefits

In some cases, other types of retirement income can affect the amount of your benefits, even if you collect them from your spouse’s account. Your benefits may be reduced to account for the income you receive from a pension based on income from a government job or from another job for which your income was not subject to Social Security taxes. This mainly affects people who work in positions of the state or local government, the federal public administration or those who have worked for a foreign company.

If you work in a government position and receive a pension for work not subject to Social Security taxes, your Social Security benefits received as a spouse or widower or widower are reduced by two-thirds of the amount of the pension. This rule is called government pension compensation (GPO).

For example, if you are eligible for $ 1,200 in Social Security but also receive $ 900 per month from a government pension, your Social Security benefits are reduced by $ 600 to account for your pension income. This means that your Social Security benefit amount is reduced to $ 600 and your total monthly income is $ 1,500.

The windfall elimination provision (WEP) reduces the unfair advantage afforded to those who receive benefits on their own account and receive income from a pension based on earnings for which they did not pay Social Security taxes. In these cases, WEP simply reduces Social Security benefits by a certain factor, depending on the applicant’s age and date of birth.

What Determines Your Social Security Benefit?

The amount of your Social Security benefit is largely determined by how much you earned during your working years, your age when you retire, and your life expectancy.

The first factor that influences your benefit amount is the average amount you earned while working. Essentially, the more you earn, the greater your profits. SSA’s annual fact sheet shows that workers who retire at full retirement age can receive a maximum benefit amount of $ 3,148 for 2021 and $ 3,345 for 2022. The Social Security Administration calculates an average monthly benefit amount based on your average income and the number of years you are expected to live.

In addition to these factors, your age when you retire also plays a crucial role in determining your benefit amount. While you can begin receiving Social Security benefits at age 62, your benefit amount decreases for each month you begin collecting before your full retirement age. The full retirement age is 66 and 10 months for those who turn 62 in 2021. It increases by two months each year until the current full retirement age limit of 67 is reached for anyone born in 1960 or later.

Conversely, your benefit amount may increase if you continue to work and delay receiving benefits beyond full retirement age. For example, in 2021, the maximum monthly benefit amount for those who retire at full retirement age is $ 3,148. For those who retire early, at age 62, the maximum drops to $ 2,324, while those who wait until age 70, the last thing they can defer, can collect a benefit of $ 3,895 per month.

To ensure that benefits maintain their purchasing power, the Social Security administration adjusts them each year for changes in the cost of living. For example, starting in January 2022, the COLA will cause Social Security and Supplemental Security Income (SSI) benefits to increase by 5.9%.

The bottom line

Income from a 401 (k) plan does not affect the amount of your Social Security benefits, but it can increase your annual income to a point where it will be taxed or taxed at a higher rate. This can be a conundrum for someone at an age where they are required to begin withdrawing from 401 (k) and begin collecting Social Security.

Regardless, make sure you are aware of annual changes in Social Security income thresholds and consider tax obligations when planning for retirement or deciding how large a 401 (k) distribution will take.

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Mark Holland

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