FICA Taxes Explained

Since we live in a digital and paperless age, most of us never see our paycheck stub from our employer. However, have you ever glanced at your paystub and noticed the withholdings section? The common withholdings are company retirement plan contributions, income taxes and FICA taxes. Most of us understand the first two, but what about FICA taxes?

Federal Insurance Contributions Act (FICA)

When FICA first originated, millions of Americans were unemployed as a result of the Great Depression. At one point in 1932, 20 percent of the US population was unemployed (1)! To combat the issues stemming from the collapsed US economy, Congress passed the Social Security Act in 1935. One of the tax provisions that was enacted within the Social Security Act was the Federal Insurance Contributions Act (FICA). FICA, in simplest terms, is a payroll tax. FICA actually includes two different payroll taxes. The combination consists of Social Security tax and Medicare tax, which the IRS imposes on employee earnings. The employee and employer equally pay their portion of Social Security and Medicare taxes on those employee earnings. By contrast, self-employed individuals have to pay the full portion of Self-Employed taxes (SECA) since the employee is also the employer.  

Social Security Taxes

Social Security taxes, at least in part, financially support older Americans (at least 62 years old), disabled workers, and in some cases, families through survivors benefits. The Social Security taxes that you are paying provide direct benefits to current Americans who are listed above and receiving Social Security benefits. According to the government, 117 million Americans paid Social Security taxes and around 64 million Americans were receiving monthly benefits in June of 2019 (2). Any additional funds from our Social Security taxes are held in a trust fund to be allocated towards future benefits. 

In 2020, the Social Security tax has a ceiling on earnings of $137,700. The total Social Security tax is 12.4%. The employee and employer equally pay 6.2% towards Social Security taxes on the employee earnings. Self-Employed individuals pay 12.4% for Social Security taxes (can be offset by income tax provision). The earnings ceiling is typically adjusted each year for inflation.   

More information about Social Security benefits may be found by reading Daniel Caycedo's article, "Social Security Monthly Benefit Payments: An Origin Story".

Medicare Taxes

Medicare taxes finance Medicare (Hospital Insurance) coverage for retired American workers and disabled American workers. Medicare Hospital Insurance also known as Medicare Part A covers inpatient care in a hospital, skilled nursing facility care, inpatient care in a skilled nursing facility, hospice care and home health care (with limitations). If you have earned 40 credits (paid into Social Security and Medicare), you may not have to pay monthly premiums for Medicare Part A coverage. 

Unlike Social Security taxes, there is no income ceiling on earnings.The total Medicare tax is 2.9%. The employee and employer equally pay 1.45% towards Medicare taxes on the employee earnings. Self-Employed individuals pay 2.9% for the Medicare tax (can be offset by income tax provision). There is an additional Medicare tax on high-income earners of .9% on certain income thresholds. More information about the additional Medicare Tax may be found by visiting the IRS website.

Thanks for reading! To learn more about working with 5280 Wealth Management, visit us online at www.5280wealthmanagement.com or give me a call at 720-520-0826 to discuss your financial situation.

5280 Wealth Management LLC is a registered investment adviser offering advisory services in the State of Colorado and in other jurisdictions where exempt from registration.

References

U.S. Social Security Administration. (2020). Understanding the Benefits. (1)

History.com Editors. “Great Depression History.” History.com, A&E Television Networks, 29 Oct. 2009, www.history.com/topics/great-depression/great-depression-history. (2)

5280 Wealth Management LLC is a registered investment adviser offering advisory services in the State of Colorado and in other jurisdictions where exempt from registration.