Does an annuity count as income for Social Security?

Understanding whether your monthly annuity payments can impact your Social Security benefits is a surprisingly important part of retirement planning. Getty Images

Social Security provides a crucial financial safety net for the millions of Americans in retirement each year. But the average monthly Social Security benefit currently hovers near $2,000, and while that can make a big difference for retirees' budgets, it's typically not enough to cover all of their retirement expenses. As a result, many retirees have had to find other ways to supplement their income. And, one way to do that is by purchasing an annuity. 

Annuities, which are retirement insurance products designed to provide guaranteed income for life (or a set number of years), have become especially popular in recent years due to issues like the high-rate landscape and ongoing market volatility, which have left many retirees searching for predictability in their income streams. But as interest in annuities increases, so do questions about how these unique products interact with other types of retirement income.

One of the most common concerns is whether annuity payments count as income for Social Security purposes. An annuity can have an impact on your benefits, but perhaps not in the way you'd expect. As a result, understanding how these two income sources work together is a critical component of making the most of your retirement income. 

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Does an annuity count as income for Social Security?

Here's the good news: Annuity payments don't count as earned income for Social Security, so they won't reduce your monthly benefit. Once you reach full retirement age, your Social Security payments are locked in, and nothing you earn (or withdraw) can shrink them. That said, annuities can still impact your finances indirectly by increasing your taxable income. This happens thanks to Internal Revenue Service's (IRS) rules around provisional income. 

Provisional income is a formula the IRS uses to determine how much of your Social Security benefits, if any, are taxable. This includes:

• 50% of your Social Security benefits
• Adjusted gross income (AGI) from sources like pensions, IRA withdrawals or a job
• Tax-exempt interest, like municipal bond interest
• And yes, annuity payments

If your provisional income exceeds certain IRS thresholds, a portion of your Social Security benefits may be taxable. Here's what the threshold is currently:

• Single filers 
• If your provisional income is between $25,000 and $34,000, up to 50% of your benefits are taxable
• If your provisional income is above $34,000, up to 85% of your benefits are taxable
• Married filing jointly 
• If your provisional income is between $32,000 and $44,000, up to 50% of your benefits are taxable 
• If your provisional income is above $44,000, up to 85% of your benefits are taxable

For example, let's say you're a married retiree and are receiving $20,000 a year from Social Security and $30,000 a year from an annuity. Add in other income sources, and it's easy to see how quickly you could exceed these thresholds, meaning you'll owe taxes on a significant portion of your benefits.

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How annuities can affect your overall tax picture

While annuities don't directly lower your Social Security check, they can push your total income higher, which may create ripple effects in your retirement finances. And, one of the main considerations is how your annuity payments are taxed:

• If you purchased an annuity with pre-tax dollars (like from an IRA or 401(k) rollover), your withdrawals will be fully taxable and count toward provisional income.
• If you purchased the annuity with after-tax dollars, only the earnings portion is taxable, while the amount you contributed is a tax-free return of principal.

These tax rules matter because retirees often underestimate how quickly taxable income can add up. And, higher income can also lead to increased Medicare premiums due to Income-Related Monthly Adjustment Amount (IRMAA) surcharges. So, for high-income retirees, this means annuity payments might make a portion of Social Security taxable and could also increase healthcare costs.

However, the right Social Security and annuity withdrawal strategy can help minimize these impacts. For example, some retirees choose to delay Social Security until age 70, relying on annuity income first, to reduce overlap between income streams. Others stagger annuity withdrawals or mix them with tax-free Roth IRA distributions to keep taxable income in check.

Given the potential tax complications, it's worth stepping back to look at how an annuity fits into your retirement plan, whether you're considering buying an annuity or already have one. During this process, it may help to ask yourself:

• Will annuity payments push me over the IRS thresholds for taxable Social Security benefits?
• How will this affect my Medicare premiums?
• Do I need a strategy to manage taxable income in retirement?

Speaking with a retirement planning expert may also benefit you, as they can help you create an annuity strategy that keeps your income steady without triggering avoidable tax consequences.

The bottom line

The income from an annuity won't directly reduce your Social Security benefits, but it can push your provisional income high enough to trigger taxes on up to 85% of your Social Security payments. However, the type of annuity you own, how you structure withdrawals and your overall income picture all play a role in determining how big the impact might be.

So, if you're planning to use an annuity in retirement or already have one, it makes sense to take time to understand how this type of retirement product interacts with your Social Security benefits. After all, a little planning now can help you avoid unpleasant tax surprises later and ensure you get the most out of both income streams.