While 401(k) contributions from your wages are a great way to save for retirement and reduce your taxable income, your 401(k) deductions do not reduce your wages for purposes of calculating FICA taxes. Most 401(k) deductions are taken out of your pay on a "pre-tax" basis, but in that case, "pre-tax" refers only to income taxes. Therefore, your employer must apply the FICA tax rate to your gross earnings, even if you contribute to a 401(k).
Since FICA tax applies to all your gross earnings, you still pay FICA taxes on your 401(k) contributions. However, you won't pay income tax on those contributions until you begin receiving distributions.
What Are FICA Taxes?
FICA taxes consist of Social Security tax and Medicare tax. For the 2019 tax year, the FICA tax rate is 7.65 percent, which breaks down to 6.2 percent for Social Security and 1.45 percent for Medicare. Employers calculate the FICA tax using your gross pay.
There is an annual wage limit for Social Security tax, which means that you must only pay the tax on income up to the limit. For 2019, the wage limit is $132,900. If you make more than that amount, you will only pay Social Security tax on $132,900 of your gross annual pay. There is no wage limit for Medicare tax, however.
Your employer also pays FICA taxes on your income. If you're self-employed, you pay more in FICA, because you have no employer to cover it for you. Self-employed individuals pay 15.3 percent in FICA taxes, comprised of 12.4 percent Social Security taxes and 2.9 percent for Medicare taxes.
How 401(k) Contributions Are Made
Most 401(k) contributions are made on a pre-tax basis. "Pre-tax" simply means that your income tax on these contributions is deferred until you take payouts during retirement. In other words, your contributions to the 401(k) are taken out of your gross pay, and so they reduce your taxable income. This arrangement also allows your 401(k) account to grow tax-deferred, which means you won't pay the income taxes on that income until you begin receiving distributions from the 401(k) after you retire.
Effects on Income vs. FICA Tax
Suppose your gross pay is $1,788.54 for the biweekly pay period; you contribute 10 percent of your pay in your employer's 401(k) plan, and contributions are deducted on a pre-tax basis. This means that if you contribute 10 percent every pay period, your employer deducts 10 percent from your gross pay, or $178.85, and deposits this amount to your 401(k) account.
If your employer offers 401(k) matching, he will make the same contribution (up to a certain percentage) on your behalf. In the example above, if your employer's plan provides for matching up to 4 percent, your employer will contribute an amount equal to 4 percent of your gross income to your 401(k) at no cost to you (however, if your own contribution is less than 4 percent, your employer will only match what you put in).
Because of the pre-tax deduction for 401(k) contributions, your employer will deduct the $178.85 from your gross pay of $1,788.54, resulting in $1,609.69. That figure will be the figure that is subject to income tax.
Using the same example, the amount of pay subject to FICA tax is the full $1,788.54 – your gross earnings. In this case, the Social Security tax calculation is 6.2 percent multiplied by $1,788.54, which works out to be $110.89. The Medicare tax portion is $25.93, or 1.45 percent multiplied by $1,788.54. Your total FICA taxes are $136.82.
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