Employers may sponsor a 401(k) plan to help employees save toward retirement. The purpose of the 401(k) plan is to supplement Social Security benefits and other non-elective pension plans. If you are approaching retirement or are in retirement, you most likely want to maximize your income. At the same time, you want to minimize taxes. This may require a balance between your Social Security benefits and your 401(k) distributions.
Social Security was established in 1935 to provide Americans with a national insurance program that would pay benefits for retirement or disability. Social Security pays benefits when you retire. It also pays benefits to widows, orphans and disabled Americans. A 401(k) plan is an employer-sponsored plan designed to supplement the income you will receive from the government. Contributions are made from salary reductions and employer contributions and invested in mutual funds according to your investment tolerance.
You must be at least 62 years of age to qualify for Social Security early retirement benefits. You will not receive as much as if you wait until age 65. A 401(k) allows you to draw income for retirement starting at age 59 1/2. Some employer-plans allow an employee to retire at 55 years of age without taking a ten percent penalty on the money if they 401(k) is left at the employer after service is terminated.
Social Security as an exclusive income source is not taxed. But as you add other sources of taxable income, you may find your tax bracket increased with Social Security benefits taxed. Unless you have a Roth 401(k), which provides tax-free distributions, the money you take from your 401(k) plan will be added to income. You will receive a 1099R for the distributions from the plan. Compiling a total of all taxable income and adding it to 50 percent of your Social Security benefits determines your "provisional income" to determine your tax rate.
Tax rates are established by your provisional income. Single filers making under $25,000 pay no taxes. Provisional income of $32,000 for married filing jointly is tax-free. As provisional income goes up, the percentage of your Social Security income that is taxable goes up. Single filers making between $25,000 and $34,000 will add 50 percent of Social Security benefits to income; above $34,000 adds 85 percent of Social Security to income. The thresholds for married filers is $32,000 to $44,000 for 50 percent added to income with amounts over $44,000 adding 85 percent to income.
You have the ability to control when and how you take your retirement assets. Proper planning can help you use 401(k) assets prior to Social Security benefits kicking in then reduce 401(k) distributions after. For those looking to retire early, this is a significant consideration. Other considerations are using 401(k) assets only when you need them. Of course, if your 401(k) is a Roth 401(k), these are tax-free distributions. If your 401(k) is a tax-deferred account, you may consider speaking with a tax advisor to see if a Roth conversion makes sense for you.