Many retirees rely on Social Security to support them during their golden years. However, with the average benefit just shy of $2,000 per month, most people require something extra to make their retirement plans work. Annuities are becoming increasingly popular among retirees looking for predictable, long-term income.
In the midst of market volatility, an annuity can provide a welcome respite. You give the insurer a lump sum (usually from a 401(k) or IRA), and in exchange, they pay you monthly for the rest of your life or for as long as you choose.
That sounds good, right? However, as more people turn to annuities, questions arise: What impact do these payments have on your Social Security benefits?
So, Does an Annuity Count Against Your Social Security?
Not directly. Social Security considers annuity payments to be ordinary income rather than earned income. That’s a significant difference. If you’ve reached full retirement age (FRA), you can earn as much as you want from annuities, part-time work, or other sources without reducing your monthly Social Security check.
But there’s a catch: while your benefit is not reduced, your taxable income may be.
Here’s why: the IRS uses a concept known as provisional income to determine whether (and how much) of your Social Security benefits are taxable. Yes, annuity payments are part of the equation.
Where Things Get Tricky: The Taxable Threshold
Provisional income includes:
50% of your Social Security benefits
Your adjusted gross income (including pensions, IRA withdrawals, and yes, annuities)
Even tax-exempt interest like muni bonds
If you are single and your provisional income exceeds $25,000, or if you are married and your provisional income exceeds $32,000, a portion of your Social Security benefits become taxable. Cross the $34,000 (single) or $44,000 (joint) threshold, and up to 85% of your benefits may be taxed.
This means that while your annuity may not affect your benefit amount, it may result in a higher tax bill.
Assume you receive $20,000 in Social Security and another $30,000 from your annuity. Add in any savings withdrawals, and you’re likely in the taxable zone. Ouch.
How the Type of Annuity Changes the Game
Not all annuities are taxed equally. If you used pre-tax dollars (such as a 401(k) rollover), the entire income is taxable. However, if you purchased the annuity with after-tax funds, only the earnings are taxable; the remainder is simply a return on your initial investment.
This is where strategy becomes critical. Taxable income affects more than just your Social Security; it can also raise your Medicare premiums through IRMAA surcharges.
Planning Around the Pitfalls
A sound strategy can cushion the blow. Some retirees choose to postpone Social Security until age 70, relying on annuity income first. Others combine annuity withdrawals with tax-free Roth IRA distributions to remain below certain income thresholds.
Experts emphasize the importance of clarity. You must know exactly what income you want, when you want it, and how it fits into your overall strategy. This isn’t one-size-fits-all.
