Individuals newly eligible for Medicare benefits and Social Security payments are in a unique situation compared to their parents’ generation. Aside from government employees and a few private corporations, many people in their 60s today joined the workforce when pensions were being phased out and replaced with 401(k) plans. The question for them is how their retirement fund impacts Social Security benefits.

What is a 401(k)?

Current Medicare recipients who receive payments from a pension plan along with Social Security benefits may not be familiar with the 401(k) plan. As defined by the IRS, it is “a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.” It is named after the section of the tax code by which it is governed. Participation is voluntary with the long-term goal being retirement savings, which in itself is alluring to workers without pension plans. Additionally, employee contributions to the plan are excluded from taxable income. The 401(k) Roth option for after-tax savings was added after the initial 401(k) rollout.

For pretax savings, taxes become payable when funds are withdrawn, presumably when the individual retires and falls under a lower tax bracket. A further incentive for employees to contribute is that the law permits employers to contribute to the fund as well. When these plans were first introduced, many employers matched dollar-for-dollar up to a certain percentage of the employee’s contribution; although, over the years, it was not uncommon to see companies modifying their policies on the company match.

Optimizing Social Security benefits

Some people have health insurance coverage under a group health when they become eligible for Medicare benefits. This is often the case for people age 65 and older who continue to work or are covered under the health insurance plan offered by a spouse’s employer. In this case, Medicare recipients are subject to the rules of coordination of benefits and may be wondering if SS benefits are managed in a similar way. It may provide relief to know that SS and 401(k) plans are viewed as distinct and separate sources of income. The 401(k) plan does not count against SS. The consideration then is which fund to draw from as a source of income.

Eligibility to withdraw from the 401(k) plan is 59 and a half, but required minimum distributions do not begin until age 70 and a half or age 72, based on a law approved in December, 2019. The IRS announced that “if your 70th birthday is July 1, 2019 or later, you do not have to take withdrawals until you reach age 72.”

People eligible for Social Security may apply for payments as early as age 62, but delaying the application until age 70 results in a much larger benefit. Between full retirement age and the age of 70, the benefit increases 8% per year.

Financial planning

Since 401(k) savings does not impact Social Security benefits, some people decide to collect from both at the same time. Others find it more beneficial to draw on retirement savings and delay collecting SS benefits to take advantage of higher monthly SS payments at a later age. These are important decisions that would lend itself to a consultation with a personal financial advisor or and/or an attorney that specializes in elder law. It is a personal choice based on many variables, so seek the advice of a professional who can guide you through the development of a plan tailored for you.

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