While income you receive from your 401(k) or other qualified retirement plan does not affect the amount of Social Security retirement income benefits you receive each month, you may be required to pay taxes on some or all of your benefits if your annual income exceeds a certain threshold.
- Social Security retirement income does not change based on other retirement income, such as from 401(k) plan funds.
- Social Security benefits are instead calculated by your lifetime earnings and the age at which you elect to start taking Social Security income.
- Retirement withdrawals, however, may increase your total income tax liability including taxation on your Social Security income.
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 for which you paid Social Security taxes. Since contributions to your 401(k) are made with compensation received from employment by a U.S. company, you have already paid Social Security taxes on those dollars.
This holds true even for traditional 401(k) accounts. Contributions to traditional accounts are made with pre-tax dollars, but this tax shelter only applies to income taxes, not Social Security. While you don't pay income tax on traditional 401(k) funds until you withdraw them, you still pay Social Security taxes on the full amount of your compensation in the year you earned it.
“Contributions to a 401(k) are subject to Social Security and Medicare taxes, but are not subject to income taxes, unless you are making a Roth (after-tax) contribution,” notes Mark Hebner, founder and president of Index Fund Advisors, Inc. in Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”
The Tax Impact of 401(k) Savings
Though the amount of your benefit is not affected by your 401(k) savings, you may have to pay income taxes on some of your benefits if your combined annual income exceeds a certain amount.
The income thresholds are based on your "combined income," which is equal to the sum of your adjusted gross income (AGI) – which includes withdrawals from any retirement savings accounts – any non-taxable interest earned and one-half of your Social Security benefits. If you take large distributions from your 401(k) in any given year that you receive benefits, you are more likely to exceed the income threshold and increase your tax liability for the year.
According to the Social Security Administration, in 2018, if your total income for the year is less than $25,000 and you file as an individual, you won't be required to pay taxes on any portion of your Social Security benefits. If you file jointly as a married couple, this limit is raised to $32,000. You may be required to pay taxes on up to 50% of your benefits if you are an individual with income between $25,000 and $34,000, or if you file jointly 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. If you are married but file a separate return, you are likely to be liable for income tax on the total amount of your benefits, regardless of your income level.
Other Types of Retirement Income
In some cases, other types of retirement income may affect your benefit amount, even if you collect benefits on your spouse's account. Your benefits may be reduced to account for income you receive from a pension based on earnings from a government job or from another job for which your earnings were not subject to Social Security taxes. This primarily affects people working in state or local government positions, the federal civil service 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 widow or widower are reduced by two-thirds of the amount of the pension. This rule is called the government pension offset (GPO). For example, if you are eligible to receive $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 your Social Security benefit amount is reduced to $600, but your total monthly income is still $1,500.
The windfall elimination provision (WEP) reduces the unfair advantage given 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, the WEP simply reduces Social Security benefits by a certain factor, depending on the age and birth date of the applicant.
How Is Your Benefit Determined?
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 lifespan.
The first factor that influences your benefit amount is the average amount that you earned while working. Essentially, the more you earned, the higher your benefits will be. The SSA's annual fact sheet shows workers retiring at full retirement age will receive a maximum benefit amount of $2,788 a month in 2018 and $2,861 for 2019. 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 as early as age 62, your benefit amount is reduced for each month that you begin collecting before your full retirement age. (Full retirement age is 66 and four months for those who turn 62 in 2018 and 66 and six months for those who turn 62 in 2019. It increases by two months each year until it hits 67, so for anyone born in 1960 or after, the full retirement age will be 67.) Conversely, your benefit amount may be increased if you continue to work and delay receiving benefits beyond full retirement age. For example, in 2019, the maximum monthly benefit amount for those retiring at full retirement age is $2,861. For those retiring early, at age 62, the maximum drops to $2,209, while those who defer collection until age 70 – the latest age at which collection can commence – can collect a benefit of $3,770 per month.
To receive Social Security benefits, you must have accrued 40 credits, which you earn by working and paying into the Social Security system. Each year of work is worth a maximum of four credits, so you must work a minimum of 10 years to be eligible. However, each credit is equivalent to $1,320 of taxable earnings in 2018. Earning $5,280 in 2018 resulted in the maximum four credits. This means you could elect to stop working for the rest of year without endangering your eligibility, though this likely is not a sustainable strategy. For one thing, a lower income will mean your benefits will be lower.
The Bottom Line
Income from a 401(k) does not affect the amount of your Social Security benefits, but it can impact your annual tax bill if you earn too much. Make sure you are aware of annual changes to Social Security income thresholds and factor in tax liabilities when planning for retirement.