A reader writes in, asking:
“On the subject of social security, extremely belatedly I realized my ‘catchup’ strategy of max deferral to traditional 401(k), HSA, and sometimes traditional IRA impacts my social security benefits.
Have you looked at this at all, is there a strategy for deferrals that would take impact on social security into account? By this point the ship has sailed for us (I think), but maybe it’d be beneficial to others to keep this in mind or understand the trade offs.”
To back up a step, the effect this reader is asking about (i.e., contributions reducing your FICA tax and therefore potentially reducing your ultimate Social Security benefit) is specific to HSAs — and it only applies when contributing as a payroll deduction.
That is, contributions to a tax-deferred 401(k), contributions to a traditional IRA, and contributions made from a checking account to an HSA will all reduce your adjusted gross income (and therefore taxable income), but they do not reduce the amount that shows up in Box 3 of Form W-2 (“Social Security wages”). And they will not, therefore, reduce your ultimate Social Security benefit.
For contributions that you make to an HSA on a pre-FICA-tax basis (i.e., contributions made as payroll deductions, rather than money going from your checking account into an HSA), yes, they do reduce your Social Security wages for the year. And they will therefore reduce your ultimate Social Security benefit, unless a) the reduced amount of Social Security wages for the year is still above the limit ($160,200 for 2023) or b) you still have 35 other years of maximum taxable earnings.
Many people though (in particular, people with higher earnings histories) will actually find the net result to be positive. That is, the taxes saved are likely to be more valuable than the reduction in ultimate benefit. Specifically, that’s most likely to be true for anybody whose 35 highest years of (wage-inflation-adjusted) earnings will ultimately put them above the second “bend point” in the PIA formula. (In today’s dollars, that would require about $2.8 million in wage-inflation-adjusted earnings during those 35 years — an average of about $81,000 of earnings per year over 35 years, in today’s dollars.)
There is a bit more to it than that just earnings history though. For example, the greater the number of people who will receive a benefit on your work record, the more detrimental a smaller benefit would be. So, for example, somebody whose spouse did not work for pay and who has one or more adult disabled children would be more likely to find it advantageous to pay the additional Social Security tax, relative to another person with the same earnings history.