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, if your annual income exceeds a certain threshold, you may need to pay taxes on some or all of your benefits — and this may be due to your 401(k) distributions.
- Social Security retirement benefit income does not change based on other retirement income, such as from 401(k) plan funds.
- Instead, Social Security income is calculated from your lifetime earnings and the age at which you begin taking Social Security benefits.
- However, distributions from a 401(k) can increase your total annual income to the extent that your Social Security income will be subject to taxes.
Why doesn’t 401(k) income affect Social Security?
Your Social Security benefits are determined by the amount you earned during your working years—the years you paid into the system through Social Security taxes. Since contributions to your 401(k) are made by a U.S. company with compensation received from employment, you’ve already paid Social Security taxes on those dollars.
But wait—were your contributions to your 401(k) account not made with pre-tax dollars? Yes, but this tax shelter feature only applies to federal and state income taxes, not Social Security. You still pay Social Security taxes on the full amount of your compensation, up to a pre-determined annual limit established by the IRS in the year you earned it. This limit is typically increased annually and is currently capped at $142,800 for 2021.
Mark Hebner, founder and president of Index Fund Advisors Inc., said, “Contributions to a 401(k) are subject to Social Security and Medicare taxes, but subject to income tax unless you are making Roth (after-tax) contributions.” are not.” in Irvine, California, and author of Index Funds: 12-Step Recovery Program for Active Investors.
In short, this is why 401(k) distributions have to pay income tax when you take them, but no Social Security tax. And the amount of your Social Security benefit is not affected by your 401(k) taxable income.
Tax Impact of 401(k) Savings
Once you start taking distributions from your 401(k), or other retirement savings plan, such as an IRA, you no longer have to pay Social Security tax on the distributions for the reasons described above; You paid your dues during your working years. But if your combined annual income exceeds a certain amount, you may have to pay income tax on some of your gains.
The income limit is based on your “combined income,” which is equal to the sum of your adjusted gross income (AGI), including earned wages, withdrawals from any retirement savings accounts (such as IRAs and 401(k)s), any Includes non-earned interest, and half of your Social Security benefits). If you take large distributions from your traditional 401(k) in any given year, you get benefits — and remember, you must start taking them from all 401(k)s at age 72 — you’re more likely to get more. There is a possibility of an increase in the income limit and 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 file as an individual, you need to pay taxes on any portion of your Social Security benefits. Won’t happen. If you file jointly as a married couple, this limit is increased to $32,000.
If you are an individual with an income between $25,000 and $34,000, or if you file jointly and have an income between $32,000 and $44,000, you will receive 50% of your benefits. Taxes may have to be paid up to 85% of your gains 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 that affect Social Security benefits
In some cases, other types of retirement income can affect your benefit amount, regardless of whether you collect benefits in your spouse’s account. Your benefits may be reduced for pension income based on income from a government job or any other job for which your earnings were not subject to Social Security taxes. It primarily affects people in state or local government positions, those working in the federal civil service, or those working for a foreign company.
If you work in a government position and receive a work pension subject to Social Security taxes, your Social Security benefits received as a spouse or widow or widower are reduced by two-thirds of the pension amount. This rule is called Government Pension Offset (GPO).
For example, if you are eligible to receive $1,200 in Social Security but also receive $900 a month from a government pension, your Social Security benefits are reduced by $600, based on your pension income. . This means your Social Security benefit amount is reduced to $600, and your total monthly income is $1,500.
The Windfall Elimination Provision (WEP) reduces unfair benefits given to people who receive benefits on their account and receive income from pensions based on income for which they haven’t paid Social Security taxes. In these cases, WEP reduces Social Security benefits by a certain factor based on the applicant’s age and date of birth.
What Determines Your Social Security Benefit?
Your Social Security benefit amount is largely determined by how much you earned during your working years, your age when you retire, and your expected age.
The first factor that affects your benefit amount is the average amount you earned while working. Essentially, the more you earn, the higher your benefits. The SSA’s annual fact sheet shows that workers retiring at full retirement age can receive maximum benefit amounts of $3,148 for 2021 and $3,345 for 2022. The Social Security Administration calculates the average monthly benefit amount based on your average income and the number of times you expect to live.
In addition to these factors, your age also plays an important role in determining your benefit amount when you retire. While you can start receiving Social Security benefits as early as age 62, your benefit amount is reduced for each month you collect before your full retirement age. The full retirement age is 66 and 10 months for those who turn 62 in 2021. This increases by two months each year until it reaches the current full retirement age limit of 67 for anyone born in 1960 or later.
Conversely, your benefit amount may be increased if you continue to work and delay receiving benefits beyond full retirement age. For example, in 2021, the maximum monthly benefit amount for retirees at full retirement age is $3,148. For early retirees, at age 62, the maximum drops to $2,324, while those who wait until age 70 — the latest you can defer — can collect a benefit of $3,895 per month. Huh.
To ensure that benefits maintain their purchasing power, the Social Security Administration adjusts them each year according to changes in the cost of living. For example, by January 2022, COLA will cause Social Security and Supplemental Security Income (SSI) benefits to increase by 5.9%.
Income from a 401(k) doesn’t affect the amount of your Social Security benefits, but it can increase your annual income to the point where they will be taxed or taxed at a higher rate. This can be a conundrum for someone whose age requires both to withdraw from a 401(k) and to begin collecting Social Security.
Regardless, make sure you are aware of annual changes in Social Security income limits and factor in tax liabilities when planning for retirement or deciding how large to take 401(k) distributions.