If you have a disability that prevents you from working, you may be entitled to Social Security disability benefits. Your eligibility depends on your work history, and the amount of your benefit depends on your payroll tax payments. A 401k provided by your employer has no effect on either eligibility or benefit amount.
A 401k represents an important savings vehicle, to which you and your employer have contributed over the years. Once you reach retirement, you can draw on the 401k to support yourself, and spend the money on household necessities, medical treatment, vacations -- whatever you like. Since you funded the 401k yourself, it has no affect on your eligibility for Social Security disability. When you file for disability, you are allowed an unlimited amount of savings and other personal assets. However, there is a limit on your assets for Supplemental Security Income.
Supplemental Security Income
When you apply for Social Security, the agency screens your application for two different benefit programs: disability insurance and Supplemental Security Income (SSI). While your assets (or resources) are not limited for disability, SSI is a means-tested program. You are limited to $2,000 in assets if you are single, and $3,000 if you are married. Assets for this calculation includes savings in a 401k plan. If you expect or plan on a distribution from a 401k and have a disability application pending, you should report the distribution to Social Security, as this will affect your SSI eligibility.
Social Security Retirement
When you reach your full retirement age, your disability benefits will automatically convert to Social Security retirement benefits. In effect, your disability claim closes, and you begin collecting the retirement to which you are entitled through your payroll tax payments throughout your working life. Your 401k distributions also continue, without any effect on this conversion or on your monthly retirement benefit, which will be roughly equal to your disability benefit.
Return to Work
If you are on disability, you have the right to return to work for a limited income and still receive the monthly benefits. Social Security counts each month in which you earn more than $720 as a "month of service," and you are limited to nine months of service in a 60-month period. If you exceed nine months, then your benefits will be suspended if you begin making over the substantial gainful activity amount of $1,000 a month before taxes. If your new employer opens a 401k on your behalf and contributes to the 401k , that is considered nonwage compensation and is not counted toward your income ceiling.
If you are found to be disabled by the Social Security Administration, you can use this finding to support your case to the IRS for a penalty-free early withdrawal from your 401k . Normally, a distribution before the age of 59 1/2 would carry a 10 percent penalty, but the IRS allows these penalty-free early withdrawals for people suffering from a permanent disability.
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