If you are looking for some clarification regarding how your 401(k) withdrawals can impact your Social Security benefits, you're not alone. This can be one of the more confusing aspects of managing your retirement funds. The big question mark that most people bump into is whether or not income received from a 401(k) impacts monthly Social Security benefits. Let's explore what the answer can look like for different people based on how much they're withdrawing.
Basics of Taxability
Here's a look at the basics you need to know:
- Money that you receive from a traditional 401(k) plan is considered "ordinary income" that is subject to income tax.
- Social Security retirement benefits are not typically subject to income tax.
- Social Security retirement benefits could be subject to income tax if your annual income reaches a certain amount.
Social Security benefits that are potentially taxable include monthly retirement benefits, survivor benefits and disability benefits. Supplemental security income payments are not taxable. Next, take a look at the thresholds on 401(k) withdrawals and income to see where your numbers land you for the year.
When Social Security Benefits Are Taxable
There is actually a simple formula for finding out if your benefits could be taxable for 2020. Start by taking half of the Social Security you've collected during 2020. Next, add that to the number that represents half of your other income sources. This may be just 401(k) withdrawals if you're retired.
However, the full "income" list can include traditional wages, pension payouts, earned interest, capital gains and investment dividends. Your Social Security benefits may be taxable if your "halved" total comes out to more than $25,000 when you're filing as single.
The equation is slightly different if your tax status is married filing jointly. In this case, add half of your Social Security benefits to half of your spouse's Social Security benefits. Next, add all other combined income with your spouse for the year. Your Social Security benefits could be taxed if you end up with a number greater than $32,000.
Read More: Do You Pay Taxes on Disability Payments?
Tax Percentage of Social Security Benefits
If you meet the threshold for taxable Social Security benefits, your tax percentage can vary based on your filing status. The range is between 50 percent and 85 percent of your benefits. Here's a look at who falls into the 50 percent category.
- A person filing as single, head of household or qualifying widower with an income range of $25,000 to $34,000.
- A person who is married filing separately while living apart from their spouse with an income range of $25,000 to $34,000.
- A person who is married filing jointly with an income range of $32,000 to $44,000.
For people with slightly higher incomes, the tax rate for Social Security benefits goes as high as 85 percent. Here's a look at who falls into this category:
- A person filing as single, head of household or qualifying widower with an income above $34,000.
- A person who is married filing jointly with an income of more than $44,000.
- A person who is married filing separately while living apart from their spouse with an income above $34,000.
Considering Alternative Arrangements
It's clear to see that some people will make less overall by taking 401(k) withdrawals that bump their income into a bracket that causes Social Security benefits to be taxable. If this is the case, it may be wiser to look into an alternative arrangement that allows you to preserve your 401(k) savings.
Many people use the strategy of converting a 401(k) into a Roth IRA to avoid years and years of taxes on retirement income. While this strategy does require you to pay a "lump" tax on all of the money you convert over, you will be able to take withdrawals without making your Social Security benefits taxable because your retirement withdrawals will now be considered after-tax funds.
Social Security benefits aren't taxed by default. However, they could be if you make more than the annual threshold for tax-free benefits. The most common way that people get pushed over that threshold is through 401(k) withdrawals. Moving your money to a different type of retirement account may save you thousands and thousands of dollars in taxes in the long run.
- SSA: Income Taxes And Your Social Security Benefit
- IRS: Don’t Forget, Social Security Benefits May Be Taxable
- IRS: Amount of Roth IRA Contributions That You Can Make for 2020
- Social Security Administration. "SUMMARY of P.L. 98-21, (H.R. 1900) Social Security Amendments of 1983-Signed on April 20, 1983." Accessed Feb. 27, 2020.
- Social Security Administration. "Benefits Planner | Income Taxes And Your Social Security Benefit." Accessed Feb. 27, 2020.
- Social Security Administration. "Replacement SSA-1099." Accessed Feb. 27, 2020.
- AARP. "Which states tax Social Security benefits?" Accessed Feb. 27, 2020.
- Federation of Tax Administrators. "State Tax Agencies." Accessed Feb. 27, 2020.
- Social Security Administration. "Monthly Statistical Snapshot, January 2020." Accessed Feb. 27, 2020.
- Internal Revenue Service. "Roth Comparison Chart." Accessed Feb. 27, 2020.
- Internal Revenue Service. "Early Retirement Distributions and Your Taxes." Accessed Feb. 27, 2020.
- Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs." Accessed Feb. 27, 2020.
- Internal Revenue Service. "Instructions for Form 1098-Q," Pages 1-2. Accessed Feb. 27, 2020.
- Internal Revenue Service. "Instructions for Form 1098-Q," Page 1. Accessed Feb. 27, 2020.
- Internal Revenue Service. "Internal Revenue Bulletin: 2014-30." Accessed Feb. 27, 2020.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.