Two Agencies, Two Numbers, Opposite Concerns
Picture a 63-year-old who left his full-time shop job last year, started drawing Social Security early, and now picks up welding and small fabrication work from his garage. In a single year, he withdraws $70,000 from a traditional 401(k) to cover the mortgage and buy a truck. After business expenses, his welding work produces $10,000 in net self-employment earnings. He assumes the government sees $80,000 in income. Social Security does not. Its retirement earnings test looks only at the $10,000.
The Internal Revenue Service (IRS), meanwhile, is far more interested in the $70,000. This scenario appears routinely in retirement forums. Someone claims early, takes a large retirement-account distribution, does a little consulting or trade work, and panics that the withdrawal will trigger a benefit clawback. It will not. The same withdrawal can still make most of the Social Security benefit taxable and potentially raise Medicare premiums later. Same retiree, same year, two systems watching different numbers.
Social Security Watches the Smaller Number
Before full retirement age (FRA), Social Security applies the retirement earnings test. It counts wages from a job and net earnings from self-employment. It does not count 401(k) withdrawals, individual retirement account distributions, pension checks, annuity payments, interest, dividends, or capital gains. A retirement-account distribution represents compensation saved during earlier working years. Social Security treats the withdrawal as retirement money returning to its owner, not as payment for current work.
For the welder, the $70,000 withdrawal is invisible to the earnings test. Only the $10,000 in net welding income, after allowable business deductions and depreciation, is measured against the annual limit. In 2026, someone under full retirement age (FRA) for the entire year can earn $24,480 before withholding begins. Because his $10,000 remains below that line, no benefits are withheld.
If his net earnings exceeded the limit, Social Security would withhold $1 in benefits for every $2 above it. At full retirement age, the agency recalculates his benefit to give him credit for months in which checks were withheld. Beginning that month, the earnings test disappears entirely.
The Tax Code Watches the Larger Number
Now flip the lens. The IRS uses a measure commonly called provisional income to determine how much of a Social Security benefit becomes taxable. It combines adjusted gross income (AGI), tax-exempt interest, and half of the taxpayer’s Social Security benefits. Assuming the $70,000 came from pretax money in a traditional 401(k), nearly the entire distribution enters AGI. The $10,000 in net welding earnings enters too.
For a single filer, provisional income above $25,000 can make up to 50% of Social Security taxable. Above $34,000, up to 85% can become taxable. The corresponding thresholds for a married couple filing jointly are $32,000 and $44,000. Suppose the welder receives $24,000 in annual Social Security benefits. Half of that, $12,000, enters the provisional-income calculation. Add the $70,000 withdrawal and $10,000 of net welding earnings, and he reaches at least $92,000 before counting interest or other income.
At that level, as much as $20,400 of his $24,000 Social Security benefit can be included in taxable income. He is not paying an 85% tax rate. Up to 85% of the benefit is being taxed at his applicable ordinary income-tax rate. The earnings test ignored the largest number in his year. The tax return puts it front and center.
Medicare Opens the Tax Return Two Years Later
A large distribution can create another consequence through the income-related monthly adjustment amount (IRMAA), which raises Medicare Part B and Part D premiums for higher-income recipients. Medicare generally uses tax information from two years earlier. A withdrawal taken in 2026 would therefore generally affect 2028 premiums. The 2028 thresholds are not yet known, and this $70,000 distribution does not prove by itself that the welder will owe IRMAA. His filing status, Social Security taxation, welding income, interest, and other income all enter the calculation.
If his modified adjusted gross income (MAGI) crosses a 2028 threshold, however, the one-time withdrawal can produce one year of higher Medicare premiums long after the truck is parked in his driveway.
What to Model Before Withdrawing
Before taking a large distribution, he needs three separate calculations because no single income figure answers every question:
- Run the earnings test using wages and net self-employment earnings only. Do not add the 401(k) withdrawal to that number.
- Calculate provisional income with the taxable distribution included. This shows how much of the Social Security benefit may become taxable.
- Estimate the Medicare effect two years ahead. Splitting a withdrawal across two years can sometimes lower taxes or avoid a surcharge tier, but it can also spread higher income across two Medicare premium years. Run both versions before assuming smaller withdrawals are automatically better.
The $70,000 withdrawal does not threaten his Social Security check through the earnings test. The $10,000 welding profit is the only number that can do that. The twist is that the smaller number matters to Social Security today, while the larger one can follow him through his tax return and into Medicare later.
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