Are 401K contributions subject to FICA taxes? The answer may surprise you. Because we see this question asked so frequently, we’ve taken it upon ourselves to compile all the information you need to know. Read on below to discover how 401K contributions are taxed from a FICA standpoint/
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 income taxes, medicare tax, social security tax, and more can be impacted by this type of account.
So – are 401K contributions subject to FICA? Let’s take a deeper look! First, we’ll need to explain what a 401K plan is in the first place.
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! Learn more in our article talking about how 401K matching works.
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! Read more below to find out how the taxation elements work in each of these styles.
As 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. This means you pay fewer taxes for the year that you deduct them!
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.
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 money out of your Roth 401(k), there will be no additional taxes like income taxes that the employee needs to worry about.
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 to 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 the FICA Tax Rates?
When it comes to FICA taxes, there are two parts of taxes that make up the FICA tax. There is a Social Security tax and a 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% of FICA taxes. Learn more about understanding 401K when you’re self-employed in our blog. For now, it’s time to get into the real details you came here to learn about today – is 401k subject to FICA?
Are 401k Contributions Subject to FICA Taxes?
Now – we’ve covered enough background information on this subject. It’s time to get to the question at hand – are 401K contributions subject to FICA taxes? As with most things, the answer isn’t one-size-fits-all.
As discussed above, there are different types of 401Ks. So, 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.
In summary, traditional 401K accounts are still subject to paying income taxes on them. Roth 401Ks, on the other hand, you’ve already paid income tax – and your contributions won’t have additional taxation attached to them. Now that we’ve answered your question – is 401K subject to FICA – let’s address some common questions we have related to 401Ks and taxation in general.
Frequently Asked Questions About 401K Contributions & FICA Taxes
There you have it – we’ve answered the question you came here with: is 401k subject to FICA?
Now, understanding 401(k) contributions, different types of accounts, and taxes, in general, can be confusing. While you now have your answer about whether or not 401K contributions are subject to FICA, you may still have other questions about the topic. This is especially true for people who don’t have a history of personal finance. That is why we’ve compiled the most commonly asked questions people have when learning about this topic that you may have too!
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 include income taxes and FICA taxes!
Just remember to work with a professional on this so you can stay on track and pay income taxes whenever applicable. The last thing you want is to have your 401K garnished because you didn’t pay income tax properly.
Are FICA Taxes the Same Thing as Medicare Tax?
It’s important not to confuse FICA taxes and Medicare taxes! While Medicare tax is a part of FICA taxes, they are not the same thing. That’s because FICA taxes refer to both the 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 survivor 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 its own tax rates. The tax rate for Social Security is 6.2% of wages for employees unlike the 1.45% tax rate for Medicare.
Is 401K Subject to FICA Taxes? Wrapping Things Up
So, is 401K subject to FICA taxes? As you can see, the answer depends on the type of 401K plan you have. While traditional 401K plan contributions haven’t been taxed – and thus, will be considered FICA taxable income – Roth 401Ks are already taxed, and those contributions will not be subject to FICA.
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 on these accounts is key. Especially since they can be confusing when it comes down to understanding FICA taxes (which include Social Security and Medicare taxes), income taxes, etc. That is why you will want to make sure you get in touch with a professional!
Want to learn more about retirement planning? We have articles discussing how 401K loans work, comparing IRAs vs 401Ks, and even addressing whether or not 401Ks are worth it. Take a look and prepare yourself for a lucrative retirement lifestyle!