Retirement is one of life’s biggest transitions, and a retiree’s new financial landscape is one of the biggest changes he or she will face. Instead of drawing a paycheck or steady income from self-employment, most retirees become dependent on some form of retirement income — whether a traditional pension, income from an annuity or other investments, Social Security benefits, or some combination. Is this income taxed the same way that regular income is taxed?
What is FICA?
If you examine a paystub from your place of employment (or former place of employment), you’ll likely see your gross income for that pay period followed by various deductions — contributions to your group health care plan, contributions to your 401(k) or other retirement account, perhaps automatic deductions for life insurance premiums, and more. Prominent among these deductions are what are known as FICA taxes, short for Federal Insurance Contributions Act taxes. These taxes are imposed by the federal government and fund the Social Security and Medicare programs. Since the taxpayer will eventually see personal benefits from these taxes, in the form of Social Security benefits checks and Medicare insurance, one can argue that FICA taxes are not strictly “taxes” but up-front payments for benefits to be received later. However, the Supreme Court has ruled that taxpayers who pay FICA taxes have no accrued property right to Social Security benefits.
Employees and employers split the tab for FICA taxes. For Social Security, these taxes are 12.4 percent of gross wages, with 6.2 percent paid directly by the employer and 6.2 percent withheld from the employee’s pay, and paid by the employer on behalf of the employee. FICA taxes for Social Security are only payable on the first $110,100 of income (as of tax year 2012; the limit is adjusted annually). The maximum that anyone would pay in FICA Social Security taxes in 2012, therefore, would be $110,100 x 6.2 percent, or $6,826.20.
The Medicare portion of FICA taxes is handled differently. The total due on an employee’s income is 2.9 percent for the year, split between employer and employee; each is then responsible for paying 1.45 percent, as you can see on your paystub. However, there is no limit to wages that can be subject to Medicare tax; you will pay 1.45 percent (as will your employer) of total gross wages, no matter how much you earn.
Self-employed individuals are regarded as both “employer” and “employee” and are thus generally stuck paying the full amount of FICA taxes, 12. 4 percent for Social Security (up to the limit) and 2.9 percent for Medicare (with no limit).
FICA and Retirement
What happens when you retire? Are retirement stipends exempt from FICA taxes? According to the Internal Revenue Service, pension income, Social Security benefits, interest and dividend income, capital gains, collection of rents, and the like, are all classified as “unearned income,” and all unearned income is exempt from FICA taxes. Your retirement stipends are therefore exempt from these taxes. However, if you continue to work in some fashion in your retirement, your earnings from working will be considered “earned income” and therefore subject to FICA taxes. And if you take on consulting work, open a small business, or are self-employed in some other fashion, you’ll be subject to the full amount of FICA taxation, both employer’s and employee’s portions, on your earned income.
And, although your pension income or other unearned income is exempt from FICA taxes, that does not mean your retirement stipend is exempt from regular income tax. Even Social Security benefits are taxed to some degree, by the federal government as well as by many states.
If your financial picture is complex and you have many options as you approach retirement, you may wish to consult with a tax attorney to plot the course that is most favorable for you. A few sessions of tax planning may help you save considerably, and money that you don’t have to spend paying taxes is money that can help you enjoy your retirement that much more.
An income tax calculator is a great online calculator that can give you a rough estimate of how much money you will have to pay in taxes at the end of the year. While it will not give you the exact number that you will get from the IRS, it will get you close enough that you will be able to plan to make the payment. This can help you budget all year long so that paying your taxes is quick and easy.
Using The Calculator:
It is not difficult to use the income tax calculator. You will need to enter all of the requested information in the fields. In order to get the correct amounts for the required fields, make sure you take into account the details below. The number that this financial calculator gives you is then the amount of money that you should expect to pay.