Q Hi Rick:
I’ve been a longtime fan of yours and I hope you can help me. I am in my early 70s and I retired about five years ago. At that point in time I began collecting Social Security and my pension. Retirement is not what I thought it would be. I am totally bored. Because of that I decided to get a part-time job, which I did, and will start at the beginning of September. When I was filling out forms for the new company, they told me that they would deduct Social Security taxes from my paycheck. My first question is, is that correct? I thought that since I’m collecting Social Security that I should no longer have to pay the tax. Am I right? My second question deals with my existing Social Security benefits. I was told my new job could have a negative impact on my current benefits. When I called Social Security, they were totally unhelpful and I have no idea what they were talking about. I hope you can help me. One last question, should I use a Roth or traditional 401k?
A Dear Confused:
With regard to the first question, your new employer was 100 percent correct that they would have to withhold Social Security taxes. The fact that you are currently collecting Social Security is not relevant. The bottom line, when you have earned income, such as income from a job, you’re liable to pay Social Security taxes whether you are receiving a benefit or not. I recognize that you do not think this fair; however, my question to you is where does fairness enter into the equation? When I went to the University of Michigan Law School, the first thing that my tax professor taught me was never to equate taxes with fairness. Therefore, in your situation it may not be fair but the law is the law and you do have to pay Social Security taxes on your new job.
With regard to your current benefits, that is a different story. The way Social Security determines your benefit is based upon a number of factors, such as your past earnings and the age you begin collecting benefits. In determining the amount of your benefits, Social Security uses your 35 highest paid years. Therefore, since you have already worked for over 35 years, your current benefits would not be adversely affected.
With regard to contributing to the 401(k) Plan, the fact that you are collecting Social Security and over 70 years of age is not an issue. Therefore, as soon as your employer allows you to contribute to the 401(k) Plan, you can. In that regard, I would recommend the Roth option. The Roth gives you the opportunity to invest tax free. All the money that you contribute into the Roth will grow on a tax-free basis and, eventually when you retire the second time, the Roth 401(k) Plan can be directly transferred into a Roth IRA; that money would not be subject to the required minimum distribution at age 70½. People sometimes forget that the benefits of the Roth IRA are not just the fact that they grow tax free, which is a wonderful benefit, but in addition, they are not subject to required minimum distributions. What that basically means is that you can allow your Roth IRA to grow tax free for as long as you choose. For retirees, this provides flexibility for the future.
Just as an FYI, for many people, whether they’re collecting Social Security or not, if they are working, I recommend the Roth option. The benefit of having money grow tax free can be substantial; particularly, for someone who is just starting their career. After all, could you imagine someone who is 21 or 22 using a Roth 401(k) versus a traditional 401(k)? Having money grow tax free for 40 some years can make a substantial difference for someone in retirement.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org