Does a 401k Affect Social Security Disability?
Learn the critical distinction between Social Security disability programs and how each one views your retirement savings when determining eligibility.
Many individuals facing a disability worry that their 401(k) savings could hinder their ability to receive Social Security disability benefits. The impact of your retirement funds depends entirely on which of the two distinct Social Security disability programs you qualify for. Understanding the differences between these programs is the first step in determining how your savings will be treated.
Differentiating Social Security Disability Programs
The Social Security Administration (SSA) manages two separate programs that provide financial assistance to people with disabilities: Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). Though both use the same medical criteria to determine disability, their non-medical eligibility requirements are fundamentally different.
SSDI is an insurance program funded by payroll taxes from workers and employers. To be eligible, you must have a significant work history where you paid FICA taxes, earning “work credits.” Because it is an earned benefit, SSDI is not a need-based program, and the SSA does not consider your assets when determining eligibility.
In contrast, SSI is a need-based program funded by general tax revenues. It is designed for people who have very limited income and resources, regardless of their work history. SSI has strict financial limits, and to qualify, your countable resources must be below $2,000 for an individual and $3,000 for a couple.
Impact of a 401k on SSDI Eligibility and Benefits
The existence of a 401(k) account has no bearing on your initial eligibility for Social Security Disability Insurance (SSDI). The Social Security Administration does not have an asset limit for the program, so you can have substantial savings and still be approved if you meet the medical and work credit requirements.
Furthermore, taking distributions from your 401(k) while receiving SSDI will not reduce your monthly benefit amount. Money withdrawn from a 401(k) is considered unearned income, much like interest or dividends from investments.
This means that 401(k) distributions do not count toward the Substantial Gainful Activity (SGA) limit. The SGA limit is the threshold of monthly earnings from work that the SSA uses to determine if a person is still considered disabled.
Impact of a 401k on SSI Eligibility and Benefits
The rules for Supplemental Security Income (SSI) are completely different. Because SSI is a need-based program, the Social Security Administration considers a 401(k) to be a “countable resource.” The balance of your 401(k) is added to your other countable assets and is subject to the SSI resource limits.
For an individual to be eligible, total countable resources must not exceed $2,000, and for a couple, the limit is $3,000. Since most 401(k) accounts hold more than this, having one will make a person financially ineligible. The SSA views the funds in a 401(k) as money you can access for your support, even with an early withdrawal penalty.
If you spend down your 401(k) to get below the resource limit, any subsequent distributions are treated as unearned income. This unearned income directly reduces your monthly SSI payment on a dollar-for-dollar basis after a small initial disregard. For example, a $500 distribution could significantly reduce your SSI check for that month.
Considerations for 401k Distributions While on Disability
If you are receiving disability benefits and need to access funds from your 401(k), there are financial consequences to consider. Distributions from a traditional 401(k) are treated as ordinary income by the Internal Revenue Service (IRS) and are subject to income tax. This new income stream could also make a portion of your Social Security benefits taxable.
Withdrawing funds from a 401(k) before age 59½ incurs a 10% early withdrawal penalty. However, the IRS provides an exception to this penalty if you become “totally and permanently disabled.” To qualify, you must furnish proof that you cannot engage in any substantial gainful activity because of a qualifying physical or mental condition.
As an alternative, some 401(k) plans allow you to take out a loan against your balance. A 401(k) loan is not a taxable event, and the loan proceeds are not considered income for either SSDI or SSI purposes. The loan must be repaid with interest, and failure to repay it according to its terms will result in it being treated as a taxable distribution.