What's the difference between Social Security and a pension?
When you retire, the money you live on may come from different sources: Social Security, your 401(k) plan, IRAs, bank accounts, and—if you’re lucky—an employer pension plan. Pension plans and Social Security benefits are similar in that they can pay you a steady income like your paycheck did when you worked, but that’s where the similarity generally ends.
Social Security vs. pensions—basic differences
Social Security is a social insurance program offered by the federal government that in part provides eligible Americans with income in retirement through monthly checks. While you’re working, you and your employer fund Social Security through payroll taxes. These taxes pay benefits to current retirees, as well as other qualifying individuals such as those with certain disabilities.
Pension plans—defined benefit plans, specifically—are retirement plans offered through employers to provide employees with some guaranteed income in retirement. Unlike Social Security, employees typically don’t pay for their pension benefit—employers do. Employers that offer defined benefit plans make contributions to the plan, which are used to pay their employees’ benefits when they’re due. Pensions are valuable benefits to attract and retain employees, but they’ve declined in popularity with employers since the 1980s.
Who’s eligible to receive Social Security and pension benefits?
There are two criteria you must meet to start receiving your Social Security retirement benefits:
- Earn at least 40 credits during your working career—currently, one credit equals $1,510 in earnings, and you can earn up to four per year
- Reach age 62 (but your benefit will be reduced compared to when you reach your full retirement age)
If your employer offers a defined benefit plan, you’re generally eligible to participate and start to earn benefits on your first day of work or after a set number of months or years. Your employer may require you to complete a certain number of years before you’re vested—given ownership—of your pension plan benefit. Check your pension plan document to determine your eligibility and vesting criteria.
How much do you get paid under Social Security and your pension plan?
Your Social Security income can vary depending on when you start to receive your Social Security benefit. You get 100% of your benefit if you wait until your full retirement age, which, for anyone born after 1943, is between ages 66 and 67. If you start receiving it at age 62, the amount you receive will be permanently reduced. If you don’t start taking it until you turn age 70, the amount you receive will be permanently increased (but there’s no additional benefit to waiting past age 70).
|Year of birth||Full retirement age|
|1955||66 and 2 months|
|1956||66 and 4 months|
|1957||66 and 6 months|
|1958||66 and 8 months|
|1959||66 and 10 months|
|1960 and later||67|
Your highest 35 years of earnings (adjusted for inflation) are used to determine your Social Security income. The more you earn—and pay in Social Security taxes—the more you may receive as a Social Security benefit.
Your Social Security income is subject to cost-of-living increases. Social Security payments increase if inflation is positive in the third quarter (July–September). In contrast, your pension income may or may not be subject to a cost-of-living increase based on the pension plan document.
The earliest your employer may pay your pension benefits is age 62 (but most pension plans use age 65 as normal retirement age). Your pension plan may permit you to continue working while you receive your pension. Some pension plans may also provide early retirement benefits, giving you access to your money before your normal retirement age.
Two factors typically influence your benefit amount:
- Your years of participation in the plan
- Your average salary over a certain period
For example, a pension benefit could be calculated as follows:
Annual pension benefit = (Years of participation) * (Final 5 years’ average salary) * (2% multiplier)
So if you worked at the company for 20 years and made an average of $60,000 over your final five years, your pension benefit would be $24,000, or $2,000 per month.
What states don’t tax Social Security or pension income?
While both Social Security and pension income may be subject to federal income tax (see explanations below), you may not need to pay state taxes.
Social Security income
Only 12 states tax residents on at least a portion of their Social Security income: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia.
These 14 states don't impose state taxes on pension income: Alabama, Alaska, Florida, Illinois, Hawaii, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Social Security federal income tax
The tax you pay on Social Security depends on your combined income and your filing status. Your combined income is 50% of your Social Security income plus 100% of all your other income, including wages, interest, dividends, pension income, and capital gains.
|Filing status||Combined income||Social Security that's taxable|
|Single||Less than $25,000||0%|
|More than $34,000||85%|
|Married, filing jointly||Less than $32,000||0%|
|More than $44,000||85%|
Source: Social Security Administration.
Pension federal income tax
Pension income is 100% taxable for most plans because it wasn’t taxed before. The exception would be if you contributed after-tax money to your pension plan during your employment. In this case, you won’t pay taxes on the proportion of your benefit payment that you already paid taxes on.
Understanding your retirement income
How does Social Security and pension income differ?
- Your eligibility criteria
- Your payment amount and calculation
- How your income is taxed at the state and federal levels
What do Social Security and pensions have in common?
- Both provide steady income in retirement, provided you satisfy the eligibility criteria
- Both may start paying you as early as age 62
- Starting Social Security benefits at age 62 will result in a reduced benefit
- Starting pension benefits at age 62 is only available if your pension plan allows it
Consider working with a financial professional to plan your retirement income strategy to make the most of your hard-earned benefits.
Income-tax rules on how withdrawals are handled may vary from state to state.
Any tax-related discussion contained in this publication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of avoiding any tax penalties or promoting, marketing, or recommending to any other party any transaction or matter addressed. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this publication.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.