In addition to income taxes, your earned income each year is subject to FICA taxes, also known as payroll taxes. FICA taxes include the Social Security tax, known as the Old-Age, Survivors and Disability Insurance tax, and the Medicare tax, also known as the Hospital Insurance tax. When you’re saving for retirement through a 401(k) plan, you’ll be able to reap some tax benefits, but you can’t exempt your income from all of these taxes by contributing to a 401(k) plan. Knowing the rules for 401(k) plan contributions helps you budget for how much you’ll have after taxes are taken out.
Your 401(k) contributions will reduce your income taxes, but not your payroll taxes, while employer contributions are exempt from both income taxes and payroll taxes.
Employee Deferrals OASDI Taxable
One of the biggest motivators for people to defer more of their income to their 401(k) plan is the ability to exclude those contributions from their income taxes. However, that exclusion doesn’t apply to either the Social Security portion or the Medicare portion of FICA taxes. As a result, the more you defer to your 401(k) plan, the lower your income tax withholding will be from your paychecks, but it won’t affect the amount withheld for Social Security taxes.
Matching Contributions Exempt
If your employer makes contributions to your 401(k) plan on your behalf, you get a double tax benefit. Like your elective deferrals, employer contributions are also excluded from your taxable income. In addition, employer contributions are also exempt from Social Security taxes, which saves you another 6.2 percent in taxes.
2018 OSDI Tax
The Social Security tax rate is unchanged after the Tax Cuts and Jobs Act. However, due to inflation, the Social Security contribution and benefit base increased by $1,200 from 2017 to $128,400. As a result, the maximum Social Security tax paid by each of the employee and the employer is $7,960.80, or $15,921.60 total if you’re self employed.
OASDI Limit 2017
In 2017, the OASDI earnings limit is $127,200, which means that any earned income in excess of that amount isn’t subject to the Social Security portion of FICA taxes. For example, say your salary is $150,000. Only the first $127,200 is subject to OASDI withholding, so your last $22,800 escapes the Social Security tax. If you contribute $12,000 to your traditional 401(k) plan, that $12,000 will not only avoid OASDI tax, but also avoid income taxes as well.