Medicare provides basic medical coverage for Americans over the age of 65, and most people rely on the promise of Medicare being there when they retire. Part of the reason why people feel entitled to Medicare is that they pay taxes over the course of their careers. Below, we'll take a look at how much your Medicare tax rate is and where that money goes.
What your Medicare tax rate is
Medicare taxes get taken directly out of the paychecks of most workers. The tax rate for employees is 1.45%, which is withheld under the provisions of FICA, or the Federal Insurance Contributions Act. Your employer also has to pay an additional 1.45% of your earnings to Medicare. If you're self-employed, then you're responsible for the total of 2.9%. Unlike with Social Security, there is no Medicare cap on wages subject to tax, and no Medicare income limits apply. Therefore, there is no theoretical maximum Medicare tax for any given individual.
In addition to the standard Medicare tax rate, certain high-income individuals also have to pay what has become known as the Additional Medicare Tax. This tax is imposed on single filers who have wages, compensation, or self-employment income of more than $200,000. Joint filers have a higher threshold of $250,000, but it applies to the total combined earned income for both spouses. The rate of the Additional Medicare Tax is 0.9%, and so the total tax rate that employees pay is 2.35%. The total that self-employed individuals pay is 3.8%.
How Medicare withholding works
For most individuals, withholding for Medicare tax is simple. The complications that sometimes arise with Social Security withholding when someone has two or more jobs don't come up with Medicare, because there's no income limit on when Medicare tax is imposed. The employer just calculates the appropriate 1.45% of your wages or other compensation and takes out that amount.
With the Additional Medicare Tax, things get more complicated. For single filers, your employer will know when you've been paid more than $200,000, so withholding can be done correctly. However, your employer generally won't know what your spouse has received in compensation if you're married and file jointly, and so the right amount of withholding based on the total amount of the couple's compensation above $250,000 usually won't happen unless the family has a single earner.
If you have too little Additional Medicare Tax withheld, then penalties can apply. In order to avoid this, you can make sure you pay appropriate estimated taxes on a quarterly basis.
Paying it backward
Many people feel that they've earned their Medicare benefit because of the taxes that they've paid into the system. However, in reality, the tax revenue that you pay in Medicare taxes doesn't go toward covering your own benefit. Instead, what you pay goes toward covering the expenses of those who are currently covered under the Medicare system.
In the future, funding for your benefits should come from the payroll taxes that younger workers will pay. The problem, though, is that demographic shifts will reduce the number of younger workers per retired Medicare beneficiary, and that could pose difficulties for Medicare in providing the necessary funding from payroll taxes. As a result, it's likely that further funding from general tax revenue of the federal government will be necessary to cover a shortfall. In addition, it's possible that at some future point, lawmakers will increase the Medicare tax rate. Given that the initial tax rate for Medicare at its formation in 1966 was 0.35%, a boost would be far from unprecedented.
Know your taxes
Medicare provides necessary medical benefits for retired Americans, but that coverage comes at a cost. The payroll taxes that most workers pay is the cost of admission to the program. Being aware of what's getting taken out of your paycheck is important so that you can put the right value on the benefits you'll receive in retirement.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.