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 be required to pay taxes on some or all of your benefits if your annual income exceeds a certain threshold—and your 401(k) distributions can cause it to do that.
- Social Security retirement benefit income does not change based on other retirement income, such as from 401(k) plan funds.
- Social Security income, instead, is calculated by your lifetime earnings and the age at which you elect to start taking Social Security benefits.
- Distributions from a 401(k), however, may increase your total annual income to a point 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 of money you earned during your working years—years in which you paid into the system via 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.
But wait—weren't your contributions to your 401(k) account 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 pre-determined annual limit established by the IRS, in the year you earned it. This limit is typically increased yearly and is currently capped at $142,800 for 2021 and will increase to $147,000 in 2022.
"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, CA, and author of Index Funds: The 12-Step Recovery Program for Active Investors.
In a nutshell, this is why you owe income tax on 401(k) distributions when you take them, but not any Social Security tax. And the amount of your Social Security benefit is not affected by your 401(k) taxable income.
The Tax Impact of 401(k) Savings
Once you begin taking distributions from your 401(k), or other retirement savings plan, such as an IRA, you won't owe Social Security tax on the distribution for the reason described above; you paid your dues during your working years. But 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 earned wages, withdrawals from any retirement savings accounts (like IRAs and 401(k)s, any non-taxed interest earned, and one-half of your Social Security benefits). If you take large distributions from your traditional 401(k) in any given year that you receive benefits—and remember, you're required to start taking them from all 401(k)s once you turn 72—you are more likely to exceed the income threshold 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 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.
Other Factors Affecting Social Security Benefits
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 the 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/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, and your total monthly income is $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.
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 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 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 as early as age 62, your benefit amount is reduced for each month that 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 it hits the current full retirement age cap 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 the full retirement age. For example, in 2021, the maximum monthly benefit amount for those retiring at full retirement age is $3,148. For those retiring early, 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.
To ensure benefits maintain their buying power, the Social Security administration adjusts them every year in accordance with changes in the cost of living. For example, as of 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) does not affect the amount of your Social Security benefits, but it can boost your annual income to a point where they will be taxed or taxed at a higher rate. This can be a conundrum for someone who's at an age where they're required both to start withdrawing from the 401(k) and to start collecting Social Security.
Regardless, make sure you are aware of annual changes to Social Security income thresholds and factor in tax liabilities when planning for retirement or deciding how big a 401(k) distribution to take.