Pensions can be a big help when it comes to retirement planning, especially if you want to continue a certain standard of living into your golden years. When receiving a pension, it is vital to understand whether it is unearned or earned income and how it might impact other benefits, like Social Security retirement or Social Security disability payments.
How Pensions Work
When your employer provides a pension plan for you, this means that they deposit money into a fund each month that builds over time. When employees retire, that money pool is used in order to pay employees a certain amount of money every month in order to help with retirement expenses.
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While private pensions are not as common as they once were, the Bureau of Labor Statistics reports that 92 percent of government employees had access to retirement benefits with only 89 percent enrolled in 2021. Meanwhile, 68 percent of private-sector employees are offered retirement pension plans with only 51 percent enrolled. These pension plans come in two types:
- Defined-benefit plans
- Defined-contribution plans
In defined-benefit pension plans, the employee receives the same amount of money each month, no matter how well the pension pool is doing. In defined-contribution plans, employees still receive money each month, but the exact amount depends on how the pension is performing.
Consider also: Difference Between Pension & Retirement Plan
Earned Income Basics
According to the IRS, earned income includes anything you are paid as a result of working for yourself or an employer. Examples of earned income include the following:
- Wages, salary, tips and bonuses
- Gig work
- Self-employment income
- Union strike benefits
- Pre-retirement disability benefits
- Nontaxed combat pay
Earned income gives you access to certain tax benefits that unearned income does not, such as access to the Earned Income Tax Credit.
Unearned Income 101
For the purpose of taxes, pension income is considered unearned income, as it is not earned through regular wages, tips, self-employment or other work. The IRS includes all of the following in its definition of unearned income:
- Taxable interest
- Ordinary dividends
- Capital gain distributions
- Unemployment income
- Taxable Social Security
- Debt cancellation
- Certain trust distributions
Unearned income does not carry the same tax benefits as earned income, especially when it comes to things like the Child Tax Credit.
Most of the time, your unearned income through pensions will not impact your eligibility or payments from Social Security disability. This is because most of the time, these jobs paid Social Security taxes on your behalf. So, you can receive both a pension and Social Security disability at the same time, without worrying about one impacting the other.
According to the Social Security Administration, the one exception to this is if your job did not pay Social Security taxes on your behalf for the work you performed. In this case, sometimes your Social Security disability payment will be reduced. The only way to know for sure is to contact Social Security to explore the details of your particular case.
Consider also: Advantages & Disadvantages of Pensions
Similar to people who receive Social Security disability, most retired people who receive Social Security retirement do not need to worry about their unearned income through pensions impacting their monthly benefits through the program. As long as the job providing the pension is covered through paying Social Security taxes on your behalf, your benefit amount should be unchanged.
According to the Congressional Research Service, few people eligible for unearned income through pensions are receiving these benefits through employers who did not pay Social Security taxes. This small percentage of people will see some reduction in Social Security benefits due to their pension. The Social Security Administration can help you determine whether you fall into this category and how much your Social Security retirement payments might be reduced by your pension.
- Internal Revenue Service: Earned Income and Earned Income Tax Credit (EITC) Tables
- Internal Revenue Service: Unearned Income
- Social Security Administration: What You Need to Know When You Get Social Security Disability Benefits
- Congressional Research Service: Social Security: The Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO)
- U.S. Bureau of Labor Statistics: 68 Percent of Private Industry Workers Had Access to Retirement Plans in 2021