Lessons Learned From Examining My Payroll Taxes

As hundreds of high school kids run out this month and get their first summer job, they will also be greeted with their first wonderful paycheck… that and the phrase “What’s FICA and where did all my money go?” Ah, payroll taxes. First, some quick definitions of where your money is going other than federal, state, and local income taxes:

Social Security Tax
This is also commonly marked as FICA-O, SS, SSWT, or OASDI. If you work for an employer, 6.2% of your wages is withheld by the government for social security programs. Your employer also must contribute a 6.2% matching contribution that isn’t mentioned. For 2007, both the employee and employers contributions only apply to the first $97,500 of wages.

Medicare Tax
Also marked as FICA-M, MI, Med, or MWT, this tax is a flat 1.45% taken from your gross wages with no income limit to pay for Medicare, our national health insurance for the elderly. Your employer also kicks in another 1.45%.

Even though both of these contributions technically only go to pay current obligations and don’t even guarantee you benefits in the future, Uncle Sam is still taking 7.65% (15.3% total) out of each paycheck for help people survive their retirement years. It makes you wonder – shouldn’t we be doing at least the same on our end? Here are a few other observations from looking over my paystub:

Automatic Saving Helps Ensure Success
Notice how the government always get their payroll taxes before you even get cut a check. They know that in general people don’t budget well very well and tend to spend what they get. Can you imagine what would happen if everyone simply got a bill for Social Security and Medicare taxes at the end of the year? Yeesh. This is why you should “Pay Yourself First”, whether through automatic 401k deductions or automatic transfers into a savings account. It’s the best way to ensure it your savings will happen.

Pre-Tax Deductions Also Save On Payroll Taxes
Several other items can deducted from the paycheck automatically, on a pre-tax basis. Examples include:

  • Health, Vision, and Dental Insurance
  • Parking fees
  • Healthcare Flexible Spending Accounts (FSAs)
  • Dependent Care Spending Accounts
  • Basic Life Insurance

I always thought that this just meant I didn’t have to pay income tax on these payments, but after doing some reverse math it turns out that I’m not subject to payroll taxes on them either! Try looking at your own paystub. That’s an additional 7.65% in savings on stuff that would otherwise be paid with after-tax money, making Flexible Spending Accounts and makes buying the employer health plan even a better deal than I had previously calculated.

Unfortunately, your 401(k) contributions are subject to SS/Medicare even though they are exempt from income taxes. However, when you make a withdrawal you do then pay income taxes, but not SS/Medicare. At least for now…

Comments

  1. Steve Austin says:

    Regarding no SS/Medicare tax on 401(k) / IRA withdrawals, is that true for *conversions* to Roth IRAs as well? (Aware that such conversions *are* taxable income, of course.)

  2. Steve Austin says:

    A little experiment I’m running w.r.t. payroll taxes: each year when I get the SS statement (3 mo. before my birthday), I confirm what my (not my employer’s) contribution was, and proportionally calculate what my Medicare contribution was, as well. The SS statement also covers all previous years of employment, so you don’t have to go back and check your own records.

    Then I “shadow” deposit the money in a virtual savings accounts (1 for SS, 1 for Medicare) earning an interest rate equal to the 10-yr Treasury mean yield for that year. Once I begin drawing SS, I’ll then virtually draw 4% each year from my “shadow” deposit accounts, comparing the annual SS and Medicare benefits to what I could have done with my payroll contributions myself, compounded in FDIC-insured accounts.

    My prediction is that my Medicare benefit will probably outweigh my contribution, but that my SS benefit will not match up to what I will have done myself (remember, SS has my employer’s contribution, whereas I only have my own contribution to compound in the virtual shadow account).

  3. Darrell says:

    Actually, 401(k) and other pre-tax deductions are used to calculate your taxable gross wages in some states/localities for different types of taxes (Medicare jumps to mind for sure).

    Payroll tax rules are quite a mess in this country. There’s an entire industry based around simply calculating them (finding your taxable gross income, taking reciprocation rules between locations into account, etc).

  4. rocketc says:

    I am always sick when I get my social security benefit statement every year and figure how large that number would be if I could have put it into an ira. I hate taxes.

  5. That’s a pretty interesting experiment, especially if you started from your very first paycheck.

  6. I’ve always thought that if the Bush really wanted to drum up support for a tax cut, eliminating the automatic paycheck deduction would be an awesome way to do it. Make everybody pay their taxes (IRS, SS, Medicare) in a lump sum at the end of the year. I think many people fail to realize just how much money goes to taxes. All they look at is the “refund amount”. The fact that they are even getting a refund at all says something about how well they understand taxes… I don’t know how many people I talked to that believed they got nothing out of the Bush tax cuts because their refund amount stayed the same. As an example, I ran my girlfriend’s 2004 numbers through Taxcut 2001 and Taxcut 2004. Turns out her total tax bill was $1800 higher using the 2001 tax rates. I asked her if $1800 is “nothing”…

  7. I have a quick question..i m into a my first job and saw all those things you mentioned. It was a big time shock, I am also planning on opening a FSA account, so that i can come in lower tax bracket. My wife pretty much buyes a lot of things mentioned in that list, but she buys with coupons and discounts and MIR. What does it counts at the end when doing the taxes?? the actual price of the item or the total of the receipt cauz we spent more than 5K at CVS on but the total is never that much. Any help will be great, i dont know much about taxes…

  8. Jon – I can’t say whether your girlfriend might have benefitted from the Bush tax cuts or not, but I don’t think what you did proved anything. You used her 2004 income in both cases, right? But the tax brackets, deduct amounts, etc are adjusted each year for inflation, so as far as the tax system is concerned, $x amount earned in 2001 is “more” than $x amount in 2004, so it wouldn’t be surprising if there were more taxes paid on the amount in 2001.

  9. SavingDiva says:

    I would have never noticed. I will make sure to do a better job calculating the amount I should put in my FSA this year. I’ve already emptied my account.

  10. Its not really worth getting overly upset about how much money you put into SS/Medicare. Payroll taxes won’t be cut anytime soon. Doesn’t mean you shouldn’t complain to elected officials, but the govt has already budgeted your future payroll taxes and no President is going to drop/lower a tax that would destroy future budgets.

    And trust me, I have as much reason to complain as anyone since I’m self employed. I pay approx 15% to payroll taxes as I have to cover both sides as employer and employee.

  11. this is slightly off the topic… but more incredible thing is how much manage to have such a huge federal deficit to go along with the high tax rates.

  12. Thanks for the article … I didn’t realize that the healthcare spending accounts were pre-tax on all of those taxes … I might take a look at it more closely. I don’t have huge medical expenses, or even very predictable ones every year, so I’ve always worried more about losing the money I put in.

  13. rocketc : I won’t debate the relative merits of Social Security, but if you are going to compare what you can do on your own with what the program provides, you need to be sure to compare apples with apples – something most of the comparisons I’ve seen don’t do.

    The full name of Social Security is Federal Old-Age, Survivors, and Disability Insurance (OASDI), and as the name states, provides insurance against income loss in three areas. You can’t just compare the amount you might have in an IRA with the retirement benefits of Social Security; to be fair you have to consider the cost of buying disability and life insurance with part of your FICA taxes.

    You might still end up being better off with the IRA (likely at a higher risk level), I don’t know, but at least the comparison would be fair.

  14. The new adminstration will be left holding the AMT bag as more and more non-rich people fall into it. People don’t notice their real tax rate, they don’t notice payroll. But they do notice when they have to cut a 15K check for AMT, and then they are really mad. Major tax reform is on the way.

  15. Steve Austin says:

    ttfitz: nothing wrong with self-insuring oneself in that regard, via FDIC-insured products within a bank IRA (I suppose the risk level is a bit higher, but FDIC doesn’t seem much more so than OASDI) — better would be a Roth IRA where one does not have to draw down one’s personal insurance float at all, perhaps passing on much of one’s self-insurance premiums to heirs — and recall my claim that one may be better off doing this only with one’s own 6.2% contributions, giving FICA a huge advantage of having my employer’s contributions as well

    another question for ttfitz: rather than present method, why not just mandate all contributions (full 12.4%) go into disability and life insurance policies in the employee’s name?

  16. I have a couple of questions about the taxes I am paying. What is all this non-sense crap:

    CAS
    CASDI
    EFica
    EMed
    USS

    Does any of these take into the account of being pre-tax income. thx

  17. Jon – I think that’s a nice point, that people also don’t realize how much is actually getting taken away without them really “feeling it”. Even getting a reminder of “thanks for the $xxxx this year!” might get people more interested in where their taxes are being spent. Or people might just continue not to pay attention and instead be mesmerized by Paris Hilton…

    david re: FSAs – It depends on how picky your FSA administrator is. I think technically it’s what you paid for the item. but I’m not really sure. However, when you fax in the receipt and it’s not clear what coupon is for what you’d probably be able to reimbursed for the retail price.

    shraz – My best guesses:

    CAS – CA State withholding
    CASDI – California State Disability Insurance
    EFica – Social Security (6.2%)
    EMed – Medicare (1.45%)
    USS – Federal Tax withholding

  18. thanks :)

  19. mapgirl says:

    David: It is the total of the item you paid. Meaning, if you used a $1.00 coupon, you can fill out the FSA reimbursement form to say, “I paid $5 for the item less $1 for coupon, please reimburse me $4.”

    Once I bought tissues with OTC cold medicine and I had to take off the tissues and the tax I paid for the tissues and send in the reimbursement. Just read the rules really carefully and ask your HR person if you have a question. That’s their job.

  20. Cinnamon J. Scudworth says:

    Jason –

    Tax rates in the U.S. are some of the lowest in the world:
    http://moneycentral.msn.com/content/Taxes/P148855.asp

  21. Steve Austin (I see your old girlfriend gets an updated series this fall) – as I said, I’m not debating the relative merits of the current Social Security system; one could certainly self-insure. I just see so many times people saying things like, “I could do SO much better on my own” about Social Security, when all they are looking at are retirement benefits. It’s not unexpected, as for most folks, that’s the part they actually will collect on. But it doesn’t make for a fair comparision, that’s all I’m saying.

    Although, I must say, I have at times in my life had to purchase disability insurance on my own, and it can be a pricey little product.

  22. Steve Austin says:

    ttfitz (don’t the women tend to outlive the men?) — I was only trying to convince that paying myself my own 6.2% contribution (self-insurance) *is* a fair comparison with the Old Age benefit. I do realize it’s not a perfect equation, as there is less risk with SS (can’t outlive the benefits, but can outlive my self-insurance float). But I always remind myself that I’m not self-insuring (virtually) with my employers’ 6.2% contributions, which presumably cover the Survivors and Disability components in my virtual model.

    I should do my own homework on this, but perhaps you have the answer for me already: in terms of current aggregate FICA contributions, what % of them go to fund each of the three areas of OASDI? Is my 50% OA / 50% SDI split the unfair comparison?

  23. thanks a lot mapgirl and Jon. The reason i was asking this Q was cauz, i was going thru the receipts from Walgreens and CVS for last 6 months and I can actually get back that money from FSA account. I will check in with the account manager and will update. The way my wife does shopping at these shops is you stuff worth 50$ and you can use coupons on the total rather than the item itself and your receipt total is merely in single digits. And last 6 months spents on these recipts had been more than 8K. I donno how she does this but I will check with my manager.. thanks a lot Jon for bringing this UP..

  24. “Even though both of these contributions technically only go to pay current obligations”

    After paying current obligations, there is a surplus that goes into SS Trust Fund which is close to 2 trillion. However, the Federal Government have borrowed the entire amount for other expenses and keeps borrowing from the trust fund every year.

  25. Everyone here does realize that SS/Medicare withholding does not get banked?

    It is a direct transfer tax to those currently receiving benefits.

    All current surplus flows into the general fund.

    There is no real “trust fund,” merely bookkeeping entries for special, non-tradeable bonds (with a market value of zero).

    I’m sorry, but OASDI is NOT life insurance (the benefit paid on death is too low to consider it insurance)

    It is also a VERY poor substitute for true disability insurance.

    If you need SS disability you will absolutely need to retain a lawyer to get any benefits paid, and they will delay starting payment as long as they can get away with it (probably a legacy of all the drug and alcohol abusers who abused SSDI)

    Make sure to take advantage of any disability insurance your employer provides.

  26. rocketc says:

    Jason, your comment:

    “this is slightly off the topic? but more incredible thing is how much manage to have such a huge federal deficit to go along with the high tax rates.”

    High taxes actually decrease tax collections – low taxes increase government tax revenue. Check out the effect of Bush’s tax cuts on state and federal revenue. The best way to increase gov’t revenue is to decrease taxes and keep the economy growing. Now, if we could cut taxes and cut spending…

  27. Tom – W2 employees also pay around 15% of their pay in FICA taxes (7.65% x 2). Economically, it doesn’t matter if the language of the law says that employers pay half and employees pay half – 15% of the money that could be part of your compensation is still taken away.

  28. Steve Austin (no offense, but I’d rather watch the Bionic Woman, anyway) : I getcha now, I didn’t get what you meant before. It isn’t easy to find the breakdown, since Old Age and Survivors benefits are grouped together in most places, but best I can tell, in 2006 Old Age payments were $367 billion, Survivors $117 billion, and Disability $92 billion. Of course, discussions of private accounts like this leaves out the “social” part of Social Security – while the withholding part of the FICA taxes are regressive, the payments are progressive, so everyone with their own account probably works well for higher income folks, not so much for lower.

    Bill : Agreed that one should always get disability insurance through work if possible, but not everyone has that option. As for the life insurance question, you’ll have to help me out – according to the latest statement I got from the SSA, if I were to die today, my family would get a total survivor benefit of over $200K (paid over a number of years, of course). Just how much of a benefit does it have to be to qualify in your mind as “life insurance”?

    rocketc : “High taxes actually decrease tax collections – low taxes increase government tax revenue…The best way to increase gov?t revenue is to decrease taxes and keep the economy growing.” Cool, so if we cut taxes to zero, government revenue would skyrocket, and the national debt would be zero in no time! Seriously, there isn’t a serious economist anywhere who would say that (at least at the current level of taxation) the increase in revenue due to higher economic growth caused by a tax cut comes close to replacing the revenue lost by the cut. You point to the “effect of Bush?s tax cuts on state and federal revenue” to prove your point, but you only need to look at the increased revenue during the Clinton years after the increase in some taxes to see that any such effect is unproven by those measures.

  29. ttfitz,
    Obviously, zero taxes results in zero revenue. Most theories fall apart when taken to the extreme. Most people agree that eating carrots is healthy, but I actually know a woman who had to be hospitalized because she ate too many… doesn’t mean carrots are a bad idea.

    There are certainly many theorists who believe that revenue increases when taxes are cut. JFK, Reagan and Bush II all recognized and embraced that theory. I’m not sure if the links below will work, but they all support that idea. Tax cuts give people more money to spend, save or invest. Each of those activities generate more revenue for the federal government.

    I would not advocate abolishing taxes, but I would strongly support a national sales tax and drop the rest of them. The gov’t would have more money than it new what to do with – okay, maybe not… Our tax system is not based on increasing gov’t revenue. It is based on increasing dependence on the government and constructed to influence and control behavior.

    link

    link

    link

  30. rocketc – at certain levels of taxation, cutting taxes will usually bring economic growth, which will lead to higher revenues, but as I said, almost no real economists will say that the growth will produce enough extra income to cover the losses.

    I was going to produce a bunch of arguments of my own, but after I looked at them, I decide to ask you to just check out your own links, particularly the Heritage Foundation one. Look at chart number 2 – during the Reagan administration, with the tax cuts there was a 10% increase in revenue, under Bush II we have a 7% increase, which some might say supports your argument. But look at the Clinton years – with an INCREASE in some taxes, revenues rose 29%.

    Finally, I’d suggest you check out http://www.cbpp.org/3-8-06tax.htm where you will find actual evidence that tax cuts don’t cover the losses in revenue through growth. There you will find the evidence such as “In 1981, Congress approved very large supply-side tax cuts, dramatically lowering marginal income-tax rates. In 1990 and 1993, by contrast, Congress raised marginal income-tax rates on the well off. Despite the very different tax policies followed during these two decades, there was virtually no difference in real per-person economic growth in the 1980s and 1990s. Real per-person revenues, however, grew about twice as quickly in the 1990s, when taxes were increased, as in the 1980s, when taxes were cut.” Also, “CBO and Joint Tax Committee studies find that, if financed by government borrowing, tax cuts are more likely to harm than to help the economy over the long run, and consequently would cost more than conventional estimates indicate, rather than less. Moreover, in its recent ‘dynamic analysis’ of the impact of making the President?s tax cuts permanent, the Treasury Department reported that even under favorable assumptions, extending the tax cuts would have only a small effect on economic output. That small positive economic impact would offset no more than 10 percent of the tax cuts? cost.”

  31. rocketc says:

    ttfitz,
    You make a strong argument. The only response that I can make is that Clinton benefitted from some of the momentum of the Reagan policies and the fact that spending was somewhat held in check by a more fiscally conservative congress. Furthermore, we were heading into a pretty strong recession at the end of that administration.

    I’m sure there are better people out there to carry out this argument than I – I can’t find it right now, but remember reading a study about two years ago – commissioned by the UN, I think – that stated that the optimal taxation rate was around 15%.

  32. Can anyone tell me how to calculate federal and state taxes? I think my employer may not be deducting the correct amount. Thanks!

  33. Lov4Dixie says:

    Cinnamon J. Scudworth

    The reason our taxes are low as compared to the other countries from the link you gave us, is because these countries are big socialist countries where they have huge entitlement programs. They have become Nanny states and if we keep electing officials in this country who believe the government should bail us out every time we make irresponsible decisions in our lives our tax rates will be in the 50% range also. Take a look at the politicians running for president….they are proposing a host of give away programs at tax payer expense, and they say our country is bankrupt but their answer to every problem we have is more social programs and higher taxes on top of letting the current tax breaks expire. Currently only about 45% of Americans pay taxes…..America needs to wake up! We need to force these tax and spend idiots to pass the Fair Tax Act, then everybody rich, poor, bums, prostitutes, drug dealers, and welfare recipients will pay there fair share and no one will get a free ride!

  34. how much percent my employer must retain in my paycheck for federal taxes, married and two kids

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