How Does an Annuity Affect Social Security Benefits?
Unpack the relationship between annuity payments and Social Security. Understand their financial interplay, how different income types are treated, and tax implications.
An annuity is a financial contract, typically with an insurance company, where an individual makes a payment in exchange for regular disbursements, either immediately or at a future date. These payments can last for a set period or for life. Social Security benefits are payments provided by the U.S. government, funded through payroll taxes, to eligible individuals who are retired, disabled, or survivors of deceased workers.
How Social Security Benefits Are Calculated
An individual’s Social Security retirement benefits are primarily determined by their lifetime earnings. The Social Security Administration (SSA) calculates benefits based on “covered earnings,” which are wages and net self-employment income on which Social Security taxes were paid. The maximum amount of earnings subject to Social Security tax is adjusted annually; for 2025, this limit is $176,100.
To determine the benefit amount, the SSA first calculates the Average Indexed Monthly Earnings (AIME). This involves indexing an individual’s earnings from their 35 highest-earning years to account for changes in the national average wage index. If an individual has fewer than 35 years of earnings, zero earnings years are included, which can lower the AIME.
Once the AIME is determined, it is applied to a progressive formula with “bend points” to calculate the Primary Insurance Amount (PIA). The PIA represents the monthly benefit an individual receives if they begin collecting benefits at their Full Retirement Age (FRA). For those becoming eligible in 2025, the bend points are $1,226 and $7,391. The PIA calculation involves taking 90% of the first $1,226 of AIME, plus 32% of the AIME between $1,226 and $7,391, and 15% of the AIME above $7,391. This formula ensures that lower earners receive a higher percentage of their earnings back in benefits.
Annuity Income and Social Security
Annuity payments generally do not directly reduce an individual’s Social Security benefits. The Social Security Administration distinguishes between “earned income” (wages or self-employment income subject to Social Security taxes) and “unearned income.” Annuity payments, along with pensions, investment returns, interest, and dividends, are considered unearned income.
Social Security benefits are designed to replace a portion of lost earned income. Since annuity payments are not earned income for Social Security purposes, receiving them does not trigger a direct reduction in the monthly Social Security benefit amount.
Social Security benefits are based on contributions through payroll taxes on earned income. Annuity payments are a product of personal savings and investment, not contributions to the Social Security system. Therefore, these payments do not directly impact the benefit calculation or reduce the primary insurance amount.
Taxation of Annuities and Social Security
While annuity income does not directly reduce Social Security benefits, the taxable portion of annuity payments can indirectly affect how much of an individual’s Social Security benefits become subject to federal income tax. The Internal Revenue Service (IRS) uses “provisional income” (also known as “combined income”) to determine the taxability of Social Security benefits. Provisional income includes an individual’s adjusted gross income (AGI), any tax-exempt interest income, and 50% of their Social Security benefits.
The taxable portion of annuity payments contributes to an individual’s AGI. If this provisional income exceeds certain thresholds, a portion of Social Security benefits may become taxable. For example, for a single filer in 2025, if provisional income is between $25,000 and $34,000, up to 50% of Social Security benefits may be taxable. If provisional income exceeds $34,000, up to 85% of benefits may be taxable.
For those filing jointly, the thresholds are $32,000 and $44,000. Exceeding these thresholds due to higher AGI from taxable annuity payments means more of the Social Security benefit could be included in taxable income. This indirect effect is a tax consideration, not a reduction in the actual Social Security benefit amount paid by the SSA.
Understanding the Social Security Earnings Test
The Social Security Earnings Test can reduce Social Security benefits for individuals who work and earn above certain limits before reaching their Full Retirement Age (FRA). This test applies exclusively to “earned income,” such as wages or net earnings from self-employment. Annuity income, pension payments, and investment income are not considered earned income for this test.
Therefore, receiving annuity payments will not cause a reduction in Social Security benefits under the earnings test. For individuals under FRA for the entire year, the earnings limit is $23,400 in 2025. If earned income exceeds this amount, $1 in benefits is withheld for every $2 earned over the limit.
In the calendar year an individual reaches FRA, a higher earnings limit applies, which is $62,160 in 2025. For earnings above this limit, $1 in benefits is withheld for every $3 earned, but only earnings before the FRA month count. Once an individual reaches their FRA, the earnings test no longer applies, and they can earn any amount of income without their Social Security benefits being reduced.