Here’s the truth about retirement planning; it used to be a whole lot easier. There used to be a lot less planning involved. Life generally looked like this: work for 40 years at the same job, hang it up at age 65 and spend the remainder of your days collecting from the combination of your employer-sponsored retirement plan and social security. While it’s a bit more complicated now, the additional complications can play in your favor as long as you’re cool with asking for some help along the way.
As individuals have asked for help, I’ve fielded this question a few times recently: can your 401(k) earnings affect the amount you receive from social security in retirement?
The short answer is no.
But that doesn’t make for a very interesting blog. So—since you’re already here—let’s dig a little deeper. For starters, let’s understand the difference between the two retirement accounts in the initial question and decipher how they do, or do not, impact each other.
Social Security
Social Security is a program run by the federal government. The intent behind the program is as the name suggests, to provide some measure of financial security for recipients. When you work, you pay Social Security tax which is placed in a trust that helps support current retirees, individuals with disabilities, and living spouses and children of deceased workers.
The amount of Social Security you receive is contingent on a couple of variables. First, your lifetime earnings (which determines your lifetime contributions), and second, your retirement age.
One consideration that many retirees overlook when planning is that their Social Security income may be taxable. Not accounting for taxable income can put a figurative wrench in your budgeting. While most don’t realize that their SS benefits are taxed, (did you know before reading this?) almost all recipients will be taxed. At $32,000 of annual income, 50% of your Social Security will be taxed. At $44,000 annually, the taxable amount jumps to 85%!
In the interest of turning this short answer into a longer blog, here are a few more considerations to make when it comes to collecting Social Security. The earliest you can take your Social Security is 62 and the absolute latest you can collect is 70. If you can wait for the island and rum punch and instead punch the clock for a few more years, there may be advantages to delaying your payments in order to get a bigger distribution. If you read no further, take in this next sentence a few times. Do not count on social security as your only source of retirement income.
Do not count on social security as your only source of retirement income. Do not count on social security as your only source of retirement income. Do not count on social security as your only source of retirement income. Do not count on social security as your only source of retirement income.
401(k)
A 401(k) is an employee-sponsored account. The contributions made by your employer are usually contingent on the amount that you contribute. Similar to Social Security, 401(k)s have age considerations for distributions. At age 72, you must start receiving payments from your 401(k) through Required Minimum Distributions.
Unlike Social Security, you have input in the way your money accumulates. Most employer-sponsored plans include the Roth IRA option, which means that distributions from the account can be received without being taxed. The Roth IRA law came about in the 90s and a lot of soon-to-be retirees we work with didn’t take advantage of it. For a lot of individuals, their 401(k) is something that they set and forget, never paying attention to it until it is time to consider retirement. While there is nothing wrong with this, it may cause you to be taxed at a higher rate in retirement than if you had invested in your Roth option. It is never too early to start funding the Roth component of your 401(K) or a Roth IRA, work with your financial advisor to make a portion of your contributions to the Roth. If you are early in your career, take in this next sentence a few times. If your employer plan has a Roth component, take advantage of it! If your employer plan has a Roth component, take advantage of it! If your employer plan has a Roth component, take advantage of it! If your employer plan has a Roth component, take advantage of it! If your employer plan has a Roth component, take advantage of it!
Back to the original question. Can your 401(k) earnings affect the amount you receive from social security in retirement? The answer is still no but if you are looking at your retirement future you should be asking yourself these questions:
Should you take distributions from your 401(k)/Traditional IRA in order to defer your social security payments? It depends…maybe yes.
Should you take social security at age 62 in order to enjoy the retirement benefits you’ve earned? Again, it depends…maybe yes.
The answers to these questions are not as simple. The correct answer depends on what you want your retirement to look like. One thing is certain, the goal in all retirement planning should be to be tax efficient. This means more of your money remains for sand and sangria and less for Uncle Sam. If you’re curious about the tax efficiency of your current retirement plan, we can evaluate and score it. Reach out for a review of your financial plan.
Kirk Pearson, Wealth Advisor