The Social Security system provides income during retirement based on the amount you pay into the system during your working life through payroll taxes. Your Social Security benefits can be affected by other sources of retirement income, such as pensions and withdrawals from retirement accounts. Money you draw from a pension usually doesn't reduce your Social Security benefits directly, but it may increase taxes on your benefits and it can directly reduce benefits in certain special cases.
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Pension Income Basics
A pension is a benefit that an employer can offer that provides monthly income during retirement based on your salary and years of service. If you receive a pension from a job where you paid Social Security taxes, your pension income does not directly affect your Social Security benefits. On the other hand, a pension based on work that was not covered by Social Security, such as Federal civil service and certain jobs with state or local government agencies, may reduce Social Security benefits.
Government Pension Offset
It is possible to receive Social Security benefits based on your spouse or deceased spouse's work. If you have a pension from a government job in which you did not pay Social Security taxes and you receive Social Security benefits as a spouse or widow, your benefits are reduced by a Government Pension Offset. The GPO reduces Social Security spouse's, widow's or widower's benefits by two-thirds of the amount of your government pension.
Windfall Elimination Provision
Social Security benefits are calculated based on the taxes you pay into the system, but those with low income get a larger percentage of their pre-retirement earnings back as Social Security payments than those with higher earnings. People with pensions from jobs not covered by Social Security face different calculations for determining benefits than other workers due to a rule called the Windfall Elimination Provision aimed at preventing such workers from being treated as long-term low-wage workers and getting more than their fair share of Social Security. According to the Social Security Administration, the provision can reduce benefits by up to $395.50 a month in 2013, but the reduction is limited to half of the amount of the pension.
Income Taxes On Benefits
Even if you never worked at a job that was exempt from Social Security tax, your pension income could reduce your Social Security income indirectly by increasing the taxes you pay on it. Up to 50 percent of your Social Security may be subject to income tax if your combined income is between $25,000 and $34,000 as an individual or $32,000 and $44,000 as a married person filing a joint tax return and up to 85 percent of your benefits may be taxable if your income exceeds these ranges. Combined income includes pension income, so pension payments can potentially increase the tax rate on your Social Security benefits.