Are 401(k) Contributions Subject to FICA Taxes?

Retirement and personal finance can be tough for many Americans to deal with on their own. While there are a lot of retirement account options out there, this article is going to focus on one popular one: 401(k) plans. These accounts are not available to everyone and can be confusing at first especially when learning about how incomes taxes, medicare tax, social security tax, and more can be impacted by this type of account. Let’s take a deeper look!

What is a 401(k) Plan?

A 401(k) plan was designed with retirement in mind. It is an opportunity that plenty of American employers offer. One of the best parts about these types of accounts is the fact that there are tax advantages! When an employee signs up for a tax-advantaged retirement 401(k) account, they will put a percentage of their paycheck into their account.

This account is an investment account. Another benefit is the fact that employers could even match a portion or all of the funds that the employee contributes! Since it is an investment account, investments will need to be made. The employee has the option to choose the type of investment, but it is usually limited by the employer and is a mutual fund. There are two main types of 401(k) accounts. Each option has its own set of pros and cons! The two options to consider when it comes to a 401(k) account includes:

  • Traditional 401(k)
  • Roth 401(k)

Traditional 401(k)

Like we said earlier, each type of 401(k) account has its own set of tax advantages. Let’s start off with a Traditional 401(k). The 401(k) contributions (also known as deposits) on this type of account are put in before income taxes are taken out. That means that the 401(k) contributions can be seen as a tax deduction! When you have a tax deduction like this, it reduces your overall taxable income. Which means you pay less taxes for the year that you deduct them!

Traditional 401(k) Distributions and Taxes

Since you are getting the tax benefits at the beginning of this account with the tax deduction, it looks a little different once it’s time to take out funds. When you take funds out of your 401(k), it is known as a distribution. A distribution is just another way to talk about your withdrawal. While the funds growing in the account are not subject to income taxes, it’s a different story once you take the funds out.

People that have a Traditional 401(k) who take funds out will see that the money deals with traditional income taxes (which means the standard federal income tax rate). The amount of income tax you will need to pay depends on the tax bracket you’re in. There are some exceptions when it comes to these accounts. For example, if a person was born before January 2nd, 1936 and they take their distribution as a lump sum then that would be an exception.

Roth 401(k)

Besides a Traditional 401(k), another type of 401(k) account is a Roth 401(k). This type of account is a little bit different compared to a traditional one! That’s because 401(k) contributions for this type of account are made with after-tax dollars. That means that instead of being able to claim the funds as a tax deduction, you will see tax benefits when it’s time to take out a distribution. When you take out money out of your Roth 401(k), there will be no additional taxes like income taxes that the employee needs to worry about.

Do You Have to Pay Income Tax on a 401(k) Account?

This question can be tricky so let’s break down the answer! For a Traditional 401(k), you will need to pay income taxes on your distributions. However, you can count the funds that you put into the account as a tax deduction. On the other hand, when you have a Roth 401(k) account, the income you put into the account is after-tax. That means any and all taxes (like income taxes) have already been applied to these funds. Instead, you will see a benefit when it’s time to take funds out of the account since there will be no additional taxes applied to the distributions.

What are FICA Taxes?

Many people aren’t even aware that FICA taxes exist, let alone know that they have to pay FICA taxes. So let’s get a better understanding of what these taxes actually are. FICA refers to the Federal Insurance Contributions Act. This act was passed back in 1935 (the same year Social Security was created) and outlines what taxes need to be withheld from paychecks in order to fund programs like Social Security and Medicare. Both employees and employers deal with FICA taxes which is why it is important to have a clear understanding of it!

FICA taxes aim to give support for retirees who are able to qualify for assistance. It is also something that helps employees qualify for assistance. For example, in order to earn a Social Security credit in 2021, you needed to earn at least $1,470 and have paid FICA taxes on that amount. Annually, people can earn up to four Social Security credits. Once an individual earns 40 credits, they will be able to get Social Security retirement benefits once they are 62 years old.

What are FICA Tax Rates?

When it comes to FICA taxes, there are two parts of taxes that make up the FICA tax. There is Social Security tax and Medicare tax. The tax rate for Social Security taxes is 6.2% of wages. On the other hand, the Medicare tax rate is 1.45% of wages. By combining both the Medicare tax rate and the Social Security tax rate, the overall FICA tax rate is 7.65%. This is split with the employer who also pays Medicare tax and Social Security tax to achieve the FICA tax rate of 7.65%. However, if you are self-employed it’s different. That’s because you will need to deal with self-employment tax which is not split by the employer. That means that you would be responsible for a whopping 15.3% towards FICA taxes.

Frequently Asked Questions

Understanding 401(k) contributions, different types of accounts, and taxes can be confusing. Especially for people who don’t have a history of personal finance. That is why other people have had questions when learning about this topic that you may have too!

Are 401(k) Contributions Subject to FICA Taxes?

Potentially! It depends on the type of 401(k) account you have. For a Traditional 401(k), the 401(k) contributions you make are done with pre-tax funds. That means there has been no tax applied to them when you deposit them into the account! On the other hand, when you have a Roth 401(k), the 401(k) contributions are made with after-tax funds. That means taxes have been applied before they are deposited which includes income taxes, and FICA taxes.

Do You Pay Tax on 401(k) Distributions?

When it comes to 401(k) distributions, taxes are going to be different depending on the type of 401(k) account (just like with 401(k) contributions!). For a Traditional 401(k), the distributions you take out will be subject to taxes. On the other hand, for a Roth 401(k), the distributions are not subject to any additional taxes which includes income taxes and FICA taxes!

What to Know About Income Taxes and a 401(k) Plan?

The most important thing to keep in mind is that how income taxes will impact your 401(k) plan depends on the type of 401(k) account you have. If you need to get a better understanding then you will want to get in touch with a professional like a tax advisor or someone in your company that handles the 401(k) plans of the employees! They can answer any and all questions you may have.

Are FICA Taxes the Same Thing as Medicare Tax?

It’s important not to confuse FICA taxes and Medicare tax! While Medicare tax is a part of FICA taxes, they are not the same thing. That’s because FICA taxes refer to both Social Security tax and Medicare tax.

Is Social Security the Same as Medicare?

Since FICA taxes go towards handling programs like Social Security and Medicare, many people tend to confuse these options. Luckily, that doesn’t need to be the case because it is easier to understand the difference between Social Security and Medicare than you may realize. Social Security offers disability benefits, retirement benefits, and survivors benefits. On the other hand, Medicare helps pay for services like inpatient hospital care, nursing care, etc.

Since Social Security is a different program from Medicare, that is why each has their own tax rates. The tax rate for Social Security is 6.2% of wages for employees unlike the 1.45% tax rate for Medicare.

Overall

When it comes to planning for retirement, it is important to make sure you have a clear understanding of the options available. One popular retirement account is a 401(k) plan. However, understanding the taxes to these accounts is key. Especially since they can be confusing when it comes down to understanding FICA taxes (which includes Social Security and Medicare taxes), income taxes, etc. That is why you will want to make sure you get in touch with a professional!

Article References

https://www.investopedia.com/terms/1/401kplan.asp#toc-what-is-a-401k-plan

https://www.irs.gov/taxtopics/tc412

https://money.usnews.com/money/retirement/social-security/articles/what-is-the-fica-tax

https://www.ssa.gov/osss/prd/html/en/moreInfoLink01.html

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