401(k) and SS: Which Is Top Dog?
Your monthly Social Security benefit is determined by your age when you begin taking it and your lifetime earnings. Only annual income up to the maximum taxable earnings is counted, which includes money you put into a 401(k) plan. For 2019, that maximum is $132,900.
The longer you wait to take the benefits and the more you earned, the bigger the monthly payout.
The maximum monthly benefit in 2019 is $2,861 for someone who files at full retirement age (currently 66). Holding off as long as you can, for instance until 70, would boost that benefit to $3,770.
Click here to estimate your benefits.
So the simple answer is: No. Your 401(k) will not directly affect your benefits.
However, withdrawals from your 401(k) could make some of your Social Security benefits taxable, which affects the net amount you end up with.
To Determine If Your Benefits are Taxable…
Take one-half of your benefits plus all other income, including tax-exempt interest and 401(k) withdrawals. If that sum is more than your base amount, part of your benefits will be taxable.
Your base amount is:
- $25,000 if your are single, head of household, or a qualifying widow(er)
- $25,000 if you are married filing separately and lived apart from your spouse for all of 2018
- $32,000 if you are married filing jointly
- $0 if you are married filing separately and lived with your spouse at any time during 2018
- How much is taxable is based on your filing status and income …
- If you file as an individual and your base amount is between $25,000 and $34,000, you may have to pay tax on up to 50% of your benefits. If it’s more than $34,000, up to 85% may be taxable.
- If you file a joint return and have a base amount between $32,000 and $44,000, you’ll pay tax on up to 50% of your benefits. And if it’s more than $44,000, expect up to 85% of your benefits to be taxable.
- And if you’re married and file a separate tax return, you’ll probably pay taxes on all of your benefits.
Click here for a worksheet to check if your benefits are taxable.
5 Ways to Ease the Pain
Required Minimum Distributions (RMDs) are part of what makes up your base amount for calculating tax on Social Security benefits.
However, some planning could help shrink your 401(k), which will make the RMDs smaller and ultimately cut or eliminate the tax on your benefits …
1. Start Taking Distributions While Working
When you turn 59½ you can withdraw money from your 401(k) without paying the 10% early-withdraw penalty.
You’ll have to pay income tax on those dollars. At the same time you’re reducing the amount in your 401(k). And that could mean smaller RMDs down the road.
Make sure though, that the additional income won’t kick you into a higher tax bracket.
2. Use 401(k) to Pay Living Expenses
If you retire say at 65, use 401(k) withdraws to pay your living expenses rather than beginning Social Security benefits. That accomplishes two things:
- You’ll shrink the size of your 401(k) and ultimately the RMDs
- By postponing Social Security you could significantly boost the payouts. For every year past your full retirement age that you delay, your benefits go up by about 8% until age 70.
3. Convert to a Roth IRA
Roth IRAs aren’t subject to RMDs. Moreover, you can take unlimited tax-free distributions from a Roth without worrying about any impact on the taxation of your Social Security benefits.
However when you convert to a Roth, the amount converted is taxable at your ordinary rate. Take note:
A large conversion could push you into a higher tax bracket and make some of your Social Security benefits taxable, although it would only be for the year of conversion.
4. Charitable Contributions
You can’t give RMDs from your 401(k) tax-free to a charity. That only applies to IRAs. But there is an indirect way to make a tax-free transfer.
Simply roll over funds from your 401(k) to an IRA and then donate it to charity. Taxpayers age 70½ or older can transfer up to $100,000 a year to charities. And those donations count towards your RMDs.
Smaller RMDs could keep your income below base amounts in which Social Security benefits become taxable.
5. Go Back to Work or Keep Working
You must begin taking RMDs from your 401(k) at age 70½. Miss one and you’re looking at a 50% penalty on the amount that should have been withdrawn.
But that doesn’t apply if you’re still working.
So if you’re not quite sure you want to retire or you’re considering going back to work, a position that offers a 401(k) gives you two benefits:
- The ability to delay RMDs
- The potential for additional tax-deferred growth
And if you have a 401(k) from a previous employer, rolling it into your current employer’s plan (assuming the plan allows rollovers) will let you postpone RMDs on that money, too.
Keep in mind that if you take large distributions from your 401(k) while receiving Social Security benefits, those withdrawals could push you past the base amount and increase your income tax bill for the year.
Also, watch for any changes to the Social Security base amounts. And include income tax when planning your retirement.
To a richer life,
— Nilus Mattive
Editor, The Rich Life Roadmap