Helpful tax laws allow wage earners to contribute "pretax" money to retirement accounts, as well as health-savings accounts and employer-sponsored savings plans. This means that either your employer does not withhold anything from your wages, or you do not pay any income tax on the money before you deposit it into the account. Social Security taxes are treated differently.
Payroll Tax Withholding
For tax year 2012, employers are required to withhold 4.2 percent of gross earnings from your paycheck for Social Security taxes. Your boss also contributes 6.2 percent to the Social Security trust fund. You cannot escape the tax unless you belong to an exempt group, such as working students, foreign government employees or a qualified religious sect. When you reach $110,100 in compensation for the tax year, Social Security withholding ends -- you've reached the "wage base limit," above which your wages are not subject to Social Security taxes.
Pretax Contributions and Qualified Accounts
Many workers make regular contributions to health savings accounts, 401(k) plans or retirement savings plans. If the plan is "qualified," in IRS parlance, your employer does not withhold anything for federal income taxes before the money reaches its destination. These pretax contributions are an efficient way to build up savings for either for medical expenses or retirement.
401(k) Plans and Social Security Tax
At one time, employees were allowed to make 401(k) contributions free of both income and Social Security taxes. In 1983, however, Congress changed the rules in hope of restoring the Social Security trust fund to sound financial health. Starting in that year, the IRS required Social Security withholding on 401(k) contributions. The agency still waives income tax withholding on this money and does not consider the contributions as taxable income.
Health Savings Accounts
A Health Savings Account allows you to build up pretax savings for medical expenses. You still must pay Social Security taxes on HSA contributions, with the exception of Section 125 "cafeteria" plans, which allow employees to pay insurance premiums pretax and can also be modified to allow HSA contributions. These plans are free of both income and Social Security taxes.
Simplified Employee Pension Plans
Some contributions to a Simplified Employee Pension plan are also exempt from Social Security taxes. The IRS waives Social Security taxes on matching contributions from your employer, as well as the regular "non-elective" contribution an employee makes according to the plan guidelines. This applies only to companies where an employer/employee relation exists; there is no Social Security tax waiver for self-employed individuals administering their own SEP plan.
- Internal Revenue Service: Topic 424: 401(k) Plans
- CoreDocuments: HSA Savings Component Can Be Pre-Taxed Through a Section 125 Premium Only Plan
- Plan Sponsor Council of America: Baby Boomers, 401(k) and Social Security
- Internal Revenue Service: Publication 15: Employer Tax Guide
- InvestorGuide.com: SEP and SIMPLE Plans
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.