What is the FICA Tax and How Does It Work?
So you started a new job and finally got your first paycheck. Woo-hoo! You open your pay stub and the excitement on your face slowly fades. What are all these “deductions” and “withholdings”?
We get it. Seeing Uncle Sam taking his share out of your paycheck can be downright depressing. One of those withholdings is for your FICA tax. So what is the FICA tax, and why are you required to pay it?
Let’s go over the details.
What Is the Federal Insurance Contributions Act (FICA) Tax?
FICA stands for the Federal Insurance Contributions Act, a tax law passed in 1935 to fund what was then President Franklin D. Roosevelt’s new Social Security program. It required employers to withhold a percentage of an employee’s wages to help fund . . . you guessed it . . . Social Security.
Fast-forward to 1965 and Lyndon B. Johnson (affectionately known to Texans as the great LBJ) signs Medicare, a new health care insurance program, into law. Medicare was created to help people age 65 and older pay for their health care, as well as younger people with disabilities and people with end-stage renal disease. And how, pray tell, was Medicare going to be funded? Why, with a new tax, of course!
So today, employees pay a Social Security tax and a Medicare tax under the umbrella of the FICA tax. But it’s not just employees who have to help pay for these programs. Employers pay their share too—they have to match each employee’s contributions to the FICA tax dollar for dollar.
How FICA Taxes Work
As we discussed above, when Congress passed FICA, the whole idea was to fund a retirement savings plan (Social Security) and insurance program (Medicare) for American workers.
Let’s take a quick look at how the FICA tax breaks down:
- Social Security tax: For this part of the FICA tax, employers must withhold 6.2% of your taxable gross income (up to $160,200—what you make over that isn’t taxed). Then, your employer has to match your contribution up to that same limit.
- Medicare tax: The second portion of the FICA tax is the Medicare tax. Employers have to withhold 1.45% of each employee’s taxable wages for the Medicare tax. But unlike the Social Security tax, you don’t get a break on income over $160,200.1
And there’s more great news (insert sarcastic eye roll here): For high income earners, when your income reaches a certain threshold amount (that amount varies depending on your filing status), you have to pay what’s called an Additional Medicare Tax. That can add another 0.9% for every dollar earned above the threshold amount (more on these rates and thresholds below).2
Heads up: Since your employee has to withhold these percentages from your wages to pay the FICA tax, you’ll see these listed as deductions on your paycheck. They may be labeled as “FICA Tax” or “Withholding.” Or you may see the two portions listed individually and labeled as the “Medicare Tax” and “Social Security Tax” (the Social Security portion could also be labeled as “OSADI,” which stands for “old-age, survivors, and disability insurance”).3
Why Do I Have to Pay FICA Taxes?
Nobody likes having money withheld from their paycheck, especially for something as yucky as taxes. But if you’re an American and an employee (or an employer), chances are you’re one of the lucky millions required to pay into FICA.
Here’s the thing: When you pay your FICA taxes each year, Uncle Sam isn’t stuffing that money into a ginormous cookie jar with your name on it, ready for you to open and use when you retire.
Instead, those taxes contribute to everyone currently receiving Social Security benefits. That includes current retirees, disabled workers, and surviving spouses or children of workers who have died. Your FICA taxes also go to funding current Medicare benefits for certain elderly or disabled Americans.
And hopefully, when you qualify for Social Security and Medicare, your benefits will be funded by people who are still in the American workforce then. That’s the idea, anyway, if the government doesn’t mess with it.
2023 FICA Tax Rates and Limits
Okay, folks. Let’s get down to the nitty-gritty. As we mentioned above, FICA taxes go to funding two different programs—Social Security and Medicare. For 2023, the Social Security tax rate is 6.2% of an employee’s wages, and the Medicare tax rate is 1.45%. And remember, employers have to match these rates.
So together, you and your employer pay a total of 15.3% (7.65% + 7.65%) of your wages to FICA taxes.4
There’s no wage base limit (that’s IRS-speak for the maximum amount of your income that can be taxed) for Medicare taxes, but the 2023 wage base limit for Social Security taxes is $160,200.5 That means any income you earn above $160,200 will be taxed for Medicare, but will not be taxed for Social Security. Sweet!
Now, if your wages, compensation or self-employment income exceeds a certain threshold amount, you’ll have to tack on an additional 0.9% for the Additional Medicare Tax. Seriously, Uncle Sam? You couldn’t come up with a more creative title?
Anyway, this threshold amount for the Additional Medicare Tax depends on your filing status:
If your (or you and your spouse’s) income does not exceed your filing status’ threshold, you won’t see that 0.9% added to your FICA taxes.
How to Calculate FICA
We’ve gone over the FICA tax rates and base wage limits, so let’s look at a few examples of how to calculate FICA taxes.
A quick reminder of what we just covered above: The employee Social Security tax rate is 6.2%, and the employee Medicare tax rate is 1.45%.
Scenario 1: Let’s say you make $100,000. In that case, you’ll pay:
- $6,200 in Social Security taxes ($100,000 x 0.062)
- $1,450 in Medicare taxes ($100,000 x 0.0145)
That means you’ll shell out a total of $7,650 (7.65% of your taxable income) for FICA taxes.
Scenario 2: Let’s say you’re single and you have an income of $300,000. Hooray! But that means you’ve surpassed the threshold amount for the Additional Medicare Tax and will have to pay an additional 0.9% in FICA taxes on anything above that threshold amount. Booooo! So here are your numbers:
- $9,932 in Social Security taxes (the base wage limit of $160,200 x 0.062)
- $4,350 in Medicare taxes ($300,000 x 0.0145).
- $900 for the Additional Medicare tax (the $100,000 above the threshold x 0.009)
That’s a total of $15,182 of your taxable income for FICA taxes. Geez, Uncle Sam takes his share, doesn’t he?
I’m Self-Employed. How Does FICA Work for Me?
So you finally took the leap and started the small business you’ve been planning for since college. Now you’re the one calling the shots!
Yep, starting your own business has its rewards, but unfortunately, being self-employed doesn’t get you off the hook when it comes to paying taxes—especially paying FICA taxes. See, the Self-Employment Contributions Act (SECA) says you still have to contribute to Social Security and Medicare, even if you’re self-employed.
In fact, according to SECA, anyone who works as a freelancer, independent contractor or a self-employed worker has to pay both the employee FICA taxes and the employer match! That’s because Uncle Sam views anyone who’s self-employed as both the employee and the employer, so you end up paying the employee contribution and the employer match for SECA taxes. So double those FICA percentages:
- Social Security tax: 6.2% employee + 6.2% employer match = 12.4% total
- Medicare tax: 1.45% employee + 1.45% employer match = 2.9% total
- Additional Medicare Tax: Only applicable if you exceed the taxable income threshold for your filing status (see chart above)
Now, the SECA tax (also called the self-employment tax) has the same tax rates and limits as the FICA tax, with one minor exception: If your net self-employed income is less than $400, you don’t have to pay the SECA tax.8
What if My State Has a Social Security Tax?
Now, we’ve been talking about FICA taxes, which are federal taxes used to fund Social Security and Medicare. While no states withhold taxes from your paycheck to fund Social Security, a few do tax your Social Security benefits.8 (Just when you thought things couldn’t get any more complicated, right?) Check with your state tax agency to get details on how your Social Security benefits are taxed if you live in one of those states.
Who Doesn’t Have to Pay FICA Taxes?
Okay, so if people who work for an employer and those who are self-employed or independent contractors have to pay FICA and SECA taxes, is there anyone who doesn’t have to pay? The short answer is yes, but the chances you fall into one of these groups of people are slim:
- Civilian federal government employees hired before 1984 don’t qualify for Social Security, so they don’t have to pay that portion of FICA taxes. They’re still covered by Medicare and have to contribute the 1.45% tax for it every year, though.9
- Some state and local government employees with a pension plan don’t have to pay FICA taxes.10
- Members of certain religious organizations that are opposed to accepting health care or retirement benefits under a private plan get a pass on FICA taxes. (Certain sects of the Mennonites and Amish fall under this exemption, for example).11
- Currently enrolled students who work at their college or university can be exempt, but only for income earned from that campus job. They’ll still have to pay FICA taxes on any earnings made from a second job off-campus.
Can I Retire With Just Social Security?
Listen, folks. Betting on Social Security and Medicare as your only retirement savings and health care insurance is a terrible idea. Remember, these taxes are not used to pay for your future benefits. Instead, those payroll taxes you’re paying are collected by the IRS and sent out to folks who are currently receiving Social Security benefits (aka beneficiaries).
Today, the taxes you and about two other workers pay (2.8 workers to be exact) cover the benefits for one Social Security beneficiary. And it’s only going to get worse: By 2035, there’ll be only 2.3 workers for each beneficiary—but the number of beneficiaries will jump up by over 20 million.12 Uh-oh. Now you can see why the math on Social Security is making a lot of folks nervous.
And guess what. As of right now, Social Security is only funded until 2034. Who knows when or even if the government will extend it beyond then! So putting all your retirement savings eggs in the Social Security and Medicare baskets is not a bright idea.
Don’t rely on Washington, D.C. to take care of your retirement. Have a better plan than that. Take control of your financial future today! Our SmartVestor program can connect you with a trustworthy investing pro who can help you make a plan for your retirement savings goals.