Does Workers’ Comp Count Towards Retirement Benefits?

Workers’ compensation provides financial assistance and medical care to individuals who suffer work-related injuries or illnesses. It offers a safety net, supporting injured workers during recovery and while unable to perform their job duties. Understanding how these benefits interact with long-term financial planning, particularly retirement benefits, is a concern.

Workers’ Compensation and Earned Income for Retirement Contributions

Contributing to individual retirement accounts (IRAs), such as Traditional or Roth IRAs, and employer-sponsored plans like 401(k)s, requires “earned income.” The Internal Revenue Service (IRS) defines earned income as compensation received for personal services, including wages, salaries, tips, professional fees, and net earnings from self-employment. This definition is crucial because it dictates what types of income can be used to fund retirement savings.

Workers’ compensation benefits are not considered earned income by the IRS for retirement contribution purposes. These payments compensate for a work-related injury or illness, not for active work. Therefore, individuals cannot contribute workers’ compensation payments directly into an IRA or 401(k) unless they have other qualifying earned income.

Most workers’ compensation benefits are exempt from federal and state income taxes. This tax-exempt status is a primary reason these benefits do not qualify as earned income for retirement contributions. The IRS considers these benefits a replacement for lost wages due to injury, not taxable compensation.

If an injured worker receives workers’ compensation but also has other earned income, they can contribute to retirement accounts based on that separate earned income, as the ability to contribute depends entirely on qualifying earned income, not on workers’ compensation. While workers’ compensation provides financial support, it does not directly facilitate contributions to tax-advantaged retirement accounts.

Workers’ Compensation and Social Security Retirement Benefits

Workers’ compensation benefits can interact with Social Security benefits, particularly Social Security Disability Insurance (SSDI) benefits, through the “workers’ compensation offset.” This rule prevents individuals from receiving combined disability benefits that exceed a certain percentage of their average earnings before disability. It coordinates benefits to ensure the total amount received is not excessive.

Under this offset, the combined total of workers’ compensation and Social Security benefits (including SSDI) cannot exceed 80% of the worker’s average current earnings prior to the onset of their disability. If the combined amount surpasses this 80% threshold, the Social Security benefit is reduced to stay within the limit. This reduction is applied to the Social Security benefit, not the workers’ compensation payment itself, in most states.

For example, if a worker’s average pre-disability earnings were $4,000 per month, the 80% limit would be $3,200. If they receive $2,000 in workers’ compensation and $2,200 in SSDI (totaling $4,200), their SSDI benefit would be reduced by $1,000 to meet the $3,200 combined limit. This offset continues until the individual reaches their full retirement age or their workers’ compensation benefits cease.

While the offset is common for SSDI benefits, its application to regular Social Security retirement benefits is less frequent. The workers’ compensation offset does not directly reduce Social Security retirement benefits. However, individuals receiving both workers’ compensation and early Social Security retirement benefits might still experience an offset if their combined benefits exceed the 80% average current earnings limit.

State-specific rules or the structure of lump-sum workers’ compensation settlements can influence how this offset is calculated. Some states have “reverse offset” provisions where the workers’ compensation benefit, rather than the Social Security benefit, is reduced. When a lump-sum settlement is received, the Social Security Administration may prorate it over time to determine a monthly equivalent for offset calculation.

Workers’ Compensation and Other Retirement Plans

The interaction between workers’ compensation benefits and other retirement plans, such as employer-sponsored pensions, 401(k)s, 403(b)s, and private annuity plans, is contingent on the specific rules of each plan. These plans are governed by employer policies and federal regulations, notably the Employee Retirement Income Security Act (ERISA). ERISA sets minimum standards for private industry retirement plans, including participation, vesting, and benefit accrual.

Workers’ compensation benefits do not count as “compensation” for employer-matching contributions in defined contribution plans like 401(k)s or for calculating pension accruals. Since workers’ compensation is not considered earned income, employees cannot make their own contributions to these plans while solely receiving such benefits. This means personal contributions and potential employer matches may halt during workers’ compensation leave.

The concept of “continued employment” or “vesting” while receiving workers’ compensation benefits also depends on the specific plan documents and employer policy. Vesting refers to the point at which an employee gains non-forfeitable rights to their retirement benefits. While an employee is out of work due to a work-related injury, their ability to accrue additional years of service towards vesting or to remain eligible for employer contributions can vary.

Some employers may offer disability benefits or have specific plan provisions that allow for continued retirement contributions during a workers’ compensation absence, but this is not a universal requirement. Employees should review their employer’s plan documents or consult with their human resources department to understand the specific implications for their retirement savings.