Retirement is when we can relax and get out of the workforce. While it is nice to take a break from the daily grind of life, income taxes still have to be paid.
FICA taxes may be deducted from your paychecks if you are on a payroll. FICA (or Federal Insurance Contributions Act) is a U.S. federal tax that funds Social Security and Medicare programs and provides benefits for retirees, the disabled, and children.
One frequently asked question is whether Medicare tax is due on retirement income. You don’t usually have to pay Medicare or FICA taxes on all or most of your retirement income after retirement.
Investment Income and Medicare taxes
Most Americans depend on their retirement savings, Social Security benefits, and pension benefits to provide income after retirement. Social Security benefits are subjected to income taxes upon retirement. However, pension payments, annuities, and interest from savings or investments that you earn are not subject to Medicare or FICA taxes.
FICA taxes are paid on contributions to traditional retirement accounts such as an IRA and 401(k). These taxes are paid when the money is earned, so they don’t need to be paid again once you start making withdrawals. Your employer may match your contributions to your 401(k) retirement plan. This is exempt from Medicare taxes.
A portion of an employee’s salary is deferred. It is the amount that is paid later. This income is not available immediately, so taxes are not paid on the income. This income is subject to income taxes, Medicare, and Social Security taxes once earned.
You should expect a large tax bill if you receive deferred compensation upon retirement. Let’s suppose your employer sets aside $10,000 annually for deferred compensation. You leave the company after ten years and then retire. You will need to tax $100,000 of this deferred income in the year you receive it.
These payments can be structured differently to avoid one lump-sum payment, but that all depends on the plan details.
Employees can be eligible for severance pay and other benefits if they leave the company. You must pay taxes on any severance pay you receive from an employer.
The Sixth Circuit Court will rule in 2021 that the severance pay for a company filing bankruptcy is exempt from FICA taxes.
Paying Medicare taxes doesn’t affect your age. Your income is subject to Medicare taxes if you decide to quit your job at 65 and start working part-time. FICA taxes for those who start their own business will be higher. FICA taxes for self-employment are double the regular rate, as employers usually match the employee tax rate.
You should know what you owe and what is subject to taxation before you retire. To begin preparing, you should consult your tax professional and financial advisor.