For many retirees, Social Security serves as a crucial part of their financial support in their later years. But with the average monthly benefit falling just shy of $2,000, many retirees need additional income sources to make their retirement plans work. One popular choice is annuities, which offer predictable, long-term income, providing a stable source of funds in an otherwise uncertain market. However, a common question arises: How do annuity payments affect Social Security benefits?
So, Does an Annuity Count Against Your Social Security?
In short, no, annuity payments do not directly reduce your Social Security benefits. Social Security treats annuity payments as “ordinary income,” not “earned income.” This distinction is important because, if you’re already at full retirement age (FRA) or older, you can earn as much as you want—whether from annuities, part-time work, or other sources—without it reducing your monthly Social Security check.
However, there’s a key nuance: while your benefit amount won’t be reduced, your annuity payments could affect your taxable income.
How the IRS Looks at Your Annuity Payments
The IRS determines whether and how much of your Social Security benefits will be taxed based on a measure called provisional income. Provisional income includes several types of income, including:
50% of your Social Security benefits
Your adjusted gross income (including pensions, IRA withdrawals, and annuities)
Tax-exempt interest (like muni bonds)
If your provisional income exceeds certain thresholds, a portion of your Social Security benefits becomes taxable. These thresholds are:
$25,000 for individuals
$32,000 for married couples filing jointly
If your provisional income exceeds $34,000 (individual) or $44,000 (married), up to 85% of your Social Security benefits could be taxable.
So, while an annuity won’t directly reduce your Social Security check, it can increase your taxable income, which could result in a higher tax bill.
Example of How This Works
Let’s say you receive $20,000 in Social Security benefits and $30,000 from your annuity. If you add in any savings withdrawals or other income, your total provisional income may exceed the taxable threshold. As a result, part of your Social Security benefits may be subject to tax. This can increase your tax burden, even though your Social Security amount remains unchanged.
How Different Types of Annuities Affect Your Taxes
Not all annuities are taxed the same way. The way an annuity is funded can impact its tax treatment:
Pre-tax annuities (like those funded through a 401(k) rollover): All the income from the annuity is taxable.
Post-tax annuities (purchased with after-tax dollars): Only the earnings from the annuity are taxable. The initial investment is not taxed since it was already paid with after-tax money.
This distinction is important when planning for taxes because it can impact your overall taxable income and how much you owe in taxes.
The Hidden Costs: Medicare Premiums and IRMAA Surcharges
It’s also important to note that taxable income doesn’t just affect your Social Security benefits—it could also raise your Medicare premiums. If your income exceeds certain thresholds, you may be subject to the Income-Related Monthly Adjustment Amount (IRMAA), which adds a surcharge to your Medicare Part B and Part D premiums. Annuity payments could push you into a higher income bracket, increasing your IRMAA surcharges.
Strategies to Manage Your Annuity and Social Security Income
While the taxes and surcharges might seem daunting, there are strategies to help reduce their impact. Some retirees choose to delay Social Security until age 70, relying on annuity income in the meantime. This can allow for larger Social Security payments later. Others pair annuity withdrawals with tax-free Roth IRA distributions to keep their taxable income lower.
The Importance of Financial Planning
Planning how to combine your annuity income with your Social Security benefits is crucial. It’s not a one-size-fits-all situation, and everyone’s needs and circumstances are different. Careful planning can help you avoid unpleasant tax surprises and optimize both income streams.
It’s highly recommended that retirees speak with a financial advisor or tax expert before locking in an annuity or starting withdrawals. With proper guidance, a few strategic decisions today can save you thousands of dollars over time.
Annuity payments do not reduce your Social Security benefits directly, but they can increase your taxable income, potentially leading to higher taxes and Medicare surcharges. The key takeaway is that good planning can help you minimize the tax impact and make both income sources work more effectively together. Before making any decisions, consider speaking to a financial advisor to create a strategy that aligns with your goals.
