There are several ways to increase your nest egg, but sometimes those financial streams can make things a bit more complicated when they are unexpectedly linked together. This is true with two common pillars of retirement: Social Security and 401(k). It turns out that withdrawing funds from your 401(k) could potentially impact Social Security, specifically in terms of taxes. Keep reading to learn what a withdrawal from a 401(k) means for your Social Security benefits, plus ways you can maximize your retirement funds from both.
Does withdrawing from my 401(k) affect Social Security?
Both Social Security (SS) benefits and a 401(k) are designed to help ensure financial security during retirement, but there are some key differences between the two.
Social Security is a federal government program that is funded primarily through payroll taxes. It is meant to replace a portion of a worker’s pre-retirement income when they retire. You can start receiving benefits as early as 62, though most people wait until the full retirement age of 67.
A 401(k), on the other hand, is a retirement savings plan that is sponsored by your employer. This plan allows you to contribute a portion of your pre-tax salary to a retirement account, and in many cases, you don’t have to pay taxes on the funds until retirement.
Despite their differences, there’s a frequent misconception that having a 401(k) means you’ll receive less in SS benefits.
“A common myth is that withdrawals from a 401(k) will reduce Social Security benefits,” says JustAnswer finance expert Jeffrey Stouffer, CFP. “This is not correct, as Social Security benefits are based on your highest 35 years of earnings and the FICA taxes paid on those earnings.”
How the two are actually linked: Withdrawals from 401(k) accounts have the potential to impact how much of your Social Security benefits are taxed.
Will my Social Security benefits be taxed after a withdrawal?
Traditional 401(k) accounts are pre-tax dollars, but withdrawals are taxed as ordinary income. Larger withdrawals could possibly put you into a higher tax bracket as it increases your total income that is subject to taxation.
“When receiving Social Security benefits, this amount is included in this total income calculation,” explains Stouffer. “Up to 85 percent of your Social Security benefits may be subject to tax while calculating this income.”
Here are the taxable thresholds based on total income:
For individuals:
- $25,000 to $34,000: Up to 50 percent of benefits may be taxable
- Over $34,000: Up to 85 percent of your benefits may be taxable
For those filing jointly:
- $32,000 to $44,000: Up to 50 percent
- Over $44,000: Up to 85 percent
Essentially, if you take a larger withdrawal from a 401(k) and it raises your total income, you could see your Social Security benefits taxed.
How can I avoid taxes on Social Security after a 401(k) withdrawal?
Since 401(k) withdrawals can impact your total income, you may be wondering how you can prevent them from leading to taxation on your SS benefits. The key: Being mindful about how much money you pull from the account.
“Income planning will keep the total amounts received below the thresholds where taxing benefits can be done—as long as those minimal amounts comply with any required minimum distribution (RMD) requirements,” says Stouffer.
If you have significant assets in a 401(k) account, he recommends taking some extra steps before you begin receiving Social Security. Converting the account from a pre-tax account to a Roth after-tax account will allow you to avoid taxes.
“After the conversion, the withdrawals are no longer added into the tax calculations,” he adds. It’s important to do this, however, before you apply for Social Security to reap the benefits.
When should I start taking 401(k) withdrawals?
When it comes to financial security in retirement, timing is everything! Knowing when to access your retirement funds can make a difference in not only how you’re taxed, but also the amount of money you receive.
For example, the minimum age you can start making a withdrawal from a 401(k) is 59 ½, and it’s actually recommended to do so. The reason: It will make it easier to hold off on applying for SS.
“Delaying Social Security to age 70 will result in the largest benefit possible,” advises Stouffer. “In the years up to that point, drawing more from the 401(k) to fill that void will help. While doing this, the 401 (k) will be smaller and so will the RMDs.”
One important note: Some exceptions allow you to withdraw from a 401(k) before that minimum age, but it will result in additional tax penalties (usually 10 percent). For that reason, it’s best to avoid doing so unless your life circumstances warrant it.
