Social Security vs. 401(k)

Social Security Administration building

When planning for retirement, it’s important to consider what income streams you’ll have to cover living expenses. For many people, Social Security is a key part of the income puzzle though it may be accompanied by a 401(k) plan. If you’re just getting started with retirement planning and saving, you may be wondering what the differences are between Social Security vs. 401(k) plans. Both can help you to fund your retirement goals, though it’s important to understand what makes each of them unique.

Work with a financial advisor to maximize your opportunities to arrange the right kind of retirement income stream for you.

Are Social Security and 401(k) the Same?

When you’re talking about Social Security and 401(k) plans you’re talking about two things that fulfill a similar purpose in different ways. Social Security is a federal program that provides financial benefits to eligible people. That includes disability benefits for people who are unable to work as well as retirement benefits for people who have chosen to stop working.

The Social Security program is funded through payroll tax deductions. So if you work for an employer or are self-employed, you’ll pay Social Security tax from your earnings. This money goes into a trust fund, which pays out benefits to retirees on a monthly basis. The amount of money you can receive from Social Security retirement benefits depends largely on your earnings and marital status. The earliest you can receive Social Security retirement benefits is age 62.

A 401(k) is a defined contribution plan. These plans can be offered by employers to employees who fund them through voluntary salary deferrals. In simple terms, you can fund a 401(k) through paycheck deductions. Your employer can choose to match your contributions, though not all companies do this.

The money in your 401(k) can be invested in mutual funds, target-date funds or other securities. Your options typically depend on what the plan administrator chooses. Your 401(k) contributions grow tax-deferred and your contributions are tax-deductible. You can make qualified withdrawals from your account with no tax penalty beginning at age 59 ½. But you’ll owe income tax on the money you withdraw.

Do You Still Get Social Security If You Have a 401(k)?

Having a 401(k) plan at work doesn’t prevent you from drawing Social Security retirement benefits. The two are completely separate from one another, so whatever you get from Social Security isn’t affected by any money you’re withdrawing from a 401(k).

Receiving Social Security benefits and taking withdrawals from a 401(k) in retirement can affect your tax bracket, however. Remember, with traditional 401(k) plans withdrawals are subject to income tax. So the more you withdraw each year to supplement any benefits you’re receiving from Social Security or other sources the more you could owe in taxes.

Talking to a Social Security benefits specialist or your financial advisor can help you decide how much to withdraw from your 401(k), based on your retirement budget and what you’re getting from Social Security.

Should I Use a 401(k) Before Social Security?

401(k) documents

401(k) documents

The minimum age you can start taking Social Security retirement benefits is 62. Meanwhile, you can begin taking withdrawals from your 401(k) without a tax penalty at age 59 ½. The rule of 55 could technically allow you to take penalty-free withdrawals from a 401(k) as early as age 55 when certain conditions are met.

So, whether you should use your 401(k) before Social Security may be a moot point in terms of when you can tap into each one. There is a good reason, however, to consider relying on 401(k) withdrawals for as long as possible before taking Social Security retirement benefits. Delaying benefits longer can result in a higher benefit amount.

For example, if you can wait until age 70 to take Social Security you can receive a benefit that’s equal to 132% of your normal retirement age benefit. That’s a nice incentive to draw on your 401(k) first. If you were to take Social Security at age 62, on the other hand, your benefit amount would be reduced since you haven’t yet reached full retirement age as defined by the Social Security Administration.

Do 401(k) Contributions Reduce Social Security Benefits?

Again, it’s important to remember that your 401(k) plan is an entirely separate thing from Social Security. Your 401(k) is offered by your employer while Social Security comes from the government. So making contributions to a 401(k) will not reduce your Social Security benefits in any way.

And it’s a good idea to contribute to your 401(k) for retirement, even if you’re counting on taking Social Security benefits. For one thing, you’re getting some key tax benefits since your contributions qualify for an above-the-line tax deduction and growth is tax-deferred. For another, you can pick up some free money for retirement if your employer matches contributions.

Besides that, it’s important to remember that Social Security benefits alone may not be sufficient to meet your income needs in retirement. Making contributions to your 401(k) now could provide you with a vital source of income several decades from now when you’re ready to retire.

How to Make the Most of Social Security vs. 401(k)

Maximizing Social Security benefits revolves largely around deciding when to take benefits. You have three options:

Waiting longer to take benefits could result in a larger benefit amount. But whether that’s realistic can depend on how much you have in a 401(k), individual retirement account (IRA) or other savings accounts. So you may choose to take benefits at your normal retirement age instead.

With a 401(k) plan, maximizing your savings starts with saving as much as you can or at the very least, saving enough to get the full company matching contribution. You can also make the most of your plan by choosing low-cost investments so you’re paying less in fees.

Most importantly, remember that time is on your side with a 401(k). The longer you have to save, the more time you have to take advantage of the power of compounding interest. So if you’re just starting your career, for example, don’t pass up the opportunity to enroll in your employer’s plan. You can start small with contributions, then increase them incrementally year over year as your income grows.

The Bottom Line

Senior couple reviews their income streams

Senior couple reviews their income streams

Understanding the differences between Social Security vs. 401(k) plans is important for creating a well-rounded retirement plan. One doesn’t require you to do anything other than work and pay Social Security taxes while the other requires you to be a bit more hands-on in mapping out your retirement future. But both can play a central role in helping you to shape your retirement dreams.

Retirement Planning Tips

  • Consider talking to a financial advisor about how to coordinate Social Security benefits and 401(k) plan withdrawals into your retirement income plans. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Social Security and a 401(k) aren’t the only ways to fund your retirement. You could also contribute to an IRA, open a taxable brokerage account or purchase an annuity for guaranteed income. IRAs can offer tax advantages while taxable brokerage accounts don’t restrict the amount you can contribute on a yearly basis. And annuities can provide steady income when you’re ready to retire in exchange for an upfront premium. All of them are worth considering as you flesh out your savings strategy.

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