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.
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…