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Do 401k and IRA Contributions Reduce My Social Security Benefits?

A reader writes in, asking:

“I’m in a high tax bracket, so I’ve been making pre-tax contributions to my 401k. But it now occurs to me that if doing so reduces the amount of earnings reported to Social Security, then it will eventually reduce my Social Security benefit in retirement as well, correct? If so, wouldn’t that be one reason in favor of using Roth contributions instead? And shouldn’t this be a part of the ‘Roth or traditional IRA’ question that gets so much discussion?

Also, I signed up for the new online Social Security statement to check my earnings record and estimated benefits. Which number from my tax return is the earnings for each year supposed to match?”

Checking Your Earnings Record

If you worked as an employee, the figure that should show up for a given year’s earnings record on the Social Security website is the number from box 3 (“Social Security wages”) from your Form W-2  for the year. If you had multiple jobs, it should be the total of all your box 3’s. The reason they don’t use box 1 is that the calculation for box 1 includes reductions for things like pre-tax 401(k) contributions, which reduce income taxes but not Social Security taxes.

If you were self-employed, the figure that should appear on your Social Security earnings record is line 4 (“net earnings from self-employment”) from Schedule SE. Note that this amount is not the same as the profit from your business. Rather, it’s 92.35% of the profit from your business, to account for the deduction you get for one-half of your self-employment tax.

What Effect Do IRA and 401(k) Contributions Have?

As mentioned above, pre-tax contributions that you make to an employer-sponsored retirement plan such as a 401(k) reduce your income tax, but they do not reduce your Social Security tax. The same goes for traditional IRA contributions, as well as contributions to a SEP or SIMPLE IRA.

And because they have no effect on the amount of your income that’s subject to Social Security taxes, pre-tax contributions to an IRA, 401(k), 403(b), etc. do not reduce the Social Security benefits that you will eventually receive.

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  1. A similar question crossed my mind after signing-up to check my earnings history, but in relation to payroll deductions for medical insurance/expenses since I believe those are excluded from Social Security taxes/earnings. I’m not considering giving up insurance, but I was wondering whether my FSA contributions are worthwhile since they are included in the amount that reduces SS earnings, especially since I’m currently in the 15% tax bracket?

  2. Greg,

    That’s an interesting question.

    If you wanted to do the math, I think the analysis would look something like this: Take the amount contributed per year, divide by 35 (because the formula for benefits takes average earnings of your 35 highest-earning years), and see how that would change your “primary insurance amount.”

    Then find out how much it would cost to buy an inflation-adjusted lifetime annuity at “full retirement age” that pays an amount equal to the Social Security benefit you’re missing out on by reducing your Social Security-taxed wages.

    Then ask, does it seem likely that if you invested your tax savings (15% of the amount contributed to the FSA) that it would grow into enough money to purchase the necessary annuity?

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