Finance / Your Social Security Advisor

Will Taking 401K Distributions Affect My Social Security Benefit? – Ask Rusty

rustyDear Rusty: I’m 63 and retired from work, but not drawing Social Security. I have accumulated just over $300,000 in my rollover 401K IRA. My wife is still working full time, so we have medical, dental and vision coverage. I have a few questions:

1) When I take IRA distributions throughout the year, do those dollar amounts get reported to Social Security as income?

2) If not, will my SS benefit change (will I be penalized?) for not working and having zero income as I continue to withdraw investments and show no income?

3) If my benefit will drop because of the last few years of no income, would it be advisable to start drawing Social Security now? Signed: Planning Ahead

Dear Planning Ahead: Whenever you decide to claim Social Security, they will compute your benefit amount from your lifetime earnings history. They will adjust your earnings for inflation in all years prior to the year you turned 60, find the 35 years in which you had the highest (inflation-adjusted) earnings, and use that “average indexed monthly earnings” (AIME) amount to determine your Primary Insurance Amount (PIA), which is your benefit entitlement at your full retirement age (FRA). From there, your age when you claim determines your final Social Security payment amount. Born in 1958 your FRA is 66 plus 8 months, and that is the age at which you will get 100% of your PIA. If you claim benefits before your FRA, your payment will be reduced; and if you wait until after your FRA to claim your benefit will be increased.  If you wait until you are 70 to claim, your SS payment will reach maximum (about 27% more than your FRA benefit amount). Now, to your specific questions:

1) Distributions taken from your 401k or IRA are not reported to Social Security as “earnings” and do not count toward your Social Security benefit entitlement.

2) If you have already retired from working, having zero earnings now won’t further affect your final SS payment amount because your benefit will be based upon your 35 highest-earning years. However, if you have a recent benefit estimate from Social Security, that estimate assumed that you would continue to earn at the same level you most recently reported to the IRS until you reached your FRA. So, if you got the estimate while you were still working (or shortly thereafter), the estimate is higher than your actual benefit will be. If you received the estimate a year or more after you stopped working, the estimate is more accurate. In any case, your 401K withdrawals will not count as SS earnings.

3) Claiming now would result in a permanently reduced SS benefit amount because you haven’t yet reached your full retirement age. But claiming now wouldn’t be a hedge against your current lack of earnings, because your benefit will be based upon the highest earning 35 years over your lifetime.

If you don’t already have a full 35 years of SS-covered earnings they will still use 35 years in the benefit calculation, adding $0 earnings for enough years to make it 35. If that is the case, you could offset some of those zero years in your lifetime history by returning to work now, thus increasing your benefit when you claim. If you already have at least 35 years of earnings, enjoy your retirement!

One last thing to consider: if you predecease your wife, at her FRA she will be entitled to 100% of the benefit you were receiving at your death (if that is more than her own). In other words, when you claim your benefit will affect the amount your wife can get as your widow. The longer you wait to claim, the higher your wife’s survivor benefit from you will be.

This article is intended for information purposes only and does not represent legal or financial guidance. It presents the opinions and interpretations of the AMAC Foundation’s staff, trained and accredited by the National Social Security Association (NSSA). NSSA and the AMAC Foundation and its staff are not affiliated with or endorsed by the Social Security Administration or any other governmental entity. To submit a question, visit our website (amacfoundation.org/programs/social-security-advisory) or email us at [email protected].

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Ed from FL
5 months ago

QUESTION: I worked for the state of MA for ten years and did not pay into SS. I have a pension for those ten years and am currently enjoying this benefit. Is it true that that amount will be deducted from my SS benefit when I start to draw on SS?Ed from Florida

Russell Gloor, The AMAC Foundation
5 months ago
Reply to  Ed from FL

Ed, because of your MA pension your SS benefit will be reduced, but not by the full amount of your MA pension. Since you didn’t contribute to SS while earning the MA pension, the Windfall Elimination Provision (WEP) will apply to reduce your SS benefit, but the most your SS can be reduced is 50% of your MA pension.

David
5 months ago

Simple to understand Rusty thank you, would you review with drawing from an ira, I’m 67 and on ss as of last year have a little over $105,000 in a ira what do you think?

Rusty
4 months ago
Reply to  David

IRA withdrawals won’t affect your gross monthly benefit amount, but could affect taxation of your benefits. IRA withdrawals could also affect the size of your Medicare Part B premium, and if you have Medicare premiums withheld from your Social Security, your net SS payment might be less.

Rick
5 months ago

Rusty, shouldn’t you point out that distributions will add to your income and can cause either 50% or 85% of your SS to be taxed? Lower income recipients can be careful not to withdraw enough to cause their SS to be taxed. Many times I’ve helped lower income retirees prepare their taxes who’ve withdrawn their smaller 401k’s as they retire and it makes their SS taxable. Had they withdrawn it over a few years they wouldn’t have had to pay tax on 85% of their SS. Thanks.

Rusty
4 months ago
Reply to  Rick

You are correct Rick. Please see my reply to David.

Stephen
5 months ago

I’d just like to add this: I retired at 62 and collected SS immediately. I made a sizable IRA withdrawal for home improvements. Although I had to include this on my Federal Tax Return, it had no effect on my SS as far as paying back $1 for every $2 earned over my limit.

Russell Gloor; TheAMAC Foundation
5 months ago
Reply to  Stephen

IRA withdrawals do not count as earnings, so that sizable withdrawal wouldn’t have affected your gross SS benefit amount (no penalty would apply as long as you didn’t exceed the annual earnings limit from working that year).

MariaRose
5 months ago

RMD’s are subject to taxation at time of distribution which is currently at age 72 1/2. This was decided last year in 2020 to raise the age. Getting these funds should not affect your Medicare premium because that premium amount is decided when you start Medicare at age 65. I was supposed to start getting RMD distribution this year but now have to wait and additional 2 years. I am more concerned with the current government’s plan to tax the money in the 401/IRA accounts before RMD start. I would really like to see this issue addressed as some of us don’t have ways to hide income from taxation because of the low level of savings. (In other words not millions). At my age I don’t have any work options just budget options. Okay it’s nice to have the option to retire before FRA because the money is there but those early age retirees need to realize that they do have a cost reduction in their expected income and the tax man also gets his money. Passing the tax cost to others just to avoid taxation is totally unfair. No one is thinking about the people who’s income is in that middle ground of being too high for poverty benefits and too low for high income investment classification. Don’t assume that everyone is equal when talking about retirement income, Social Security, Medicare premiums and taxation. Before FRA, any early retirement has a permanent price and if you have enough income to retire early then don’t complain about the cost.

Dan W.
5 months ago
Reply to  MariaRose

I have also heard some preliminary discussions about a so-called wealth tax but nothing concrete.

One proposal that I heard included a tax on personal wealth if one’s personal wealth was greater than $50 million.

In opposition, there is also talk that a wealth tax is unconstitutional and would require an amendment to the U.S. constitution in order to implement as was the case before the federal income tax was implemented.

Russell Gloor, The AMAC Foundation
5 months ago
Reply to  MariaRose

One quick correction: Your Medicare premium isn’t fixed when you start Medicare, and large IRA and 401k withdrawals (or other withdrawals from tax-advantaged investments) may cause a higher Medicare premium. There is a provision known as “IRMAA” (Income Related Medicare Adjustment Amount), and IRMAA will cause an increase in your Medicare premium if your total income is high enough – over $88k if you file taxes as a single, or over $176k if you file taxes as a married couple.

Dan W.
5 months ago

Good to know.

Regarding the impact of taking IRA (or 401(k)) distributions, while you point out that these distributions are not reported to Social Security as “earnings” and do not count toward one’s Social Security benefit entitlement, isn’t it true that these distributions, if taxable, are counted by Medicare when Medicare determines the amount of monthly premium that one is charged for Medicare Part B and Medicare Part D ?

Gerald Carlson
5 months ago
Reply to  Dan W.

No; I don’t believe that they are!

Russell Gloor, The AMAC Foundation
5 months ago
Reply to  Dan W.

Your Medicare Part B (and Part D) premiums for each year are determined by your provisional income from two years prior. Since your provisional income includes your RMDs, withdrawals could cause your Medicare premiums to go up as a result of “IRMAA” – the Income Related Medicare Adjustment Amount. IRMAA clip levels are different depending on IRS filing status, and Medicare premiums increase on a sliding scale related to your total provisional income. So, yes, you may pay more than the standard Medicare Part B and Part D premium if your tax-advantaged withdrawals are high enough.

Dan W.
5 months ago

Thanks for the additional information. Might be a good argument for taking charitable contributions out of one’s annual RMD but that’s a whole other topic for another day.

Certainly a lot of moving parts.