One of the first things you notice when you get your first paycheck is that your take-home pay is less than your wage or salary would suggest. That's because part of your earnings gets withheld to cover taxes, and a big part of that withholding goes toward Social Security and Medicare taxes. Below, you'll learn just how much of your hard-earned money goes toward funding those programs, and how some policymakers are looking to change that.
Social Security, Medicare, and FICA
Tax withholding can appear on your paycheck in different ways depending on how your employer handles its payroll. Some employers break out Social Security taxes separately from Medicare taxes. Others lump them into one big category called FICA, which stands for the Federal Insurance Contributions Act. That's the law that requires employers to withhold wages to cover those taxes.
For 2016, your employer will collect Social Security taxes at a rate of 6.2% on the first $118,500 of your work earnings. That means that regardless of how much money you make, the amount you could have to pay in Social Security taxes maxes out at $7,347. Your employer has to match your withheld amount with its own 6.2% tax payment out of the employer's own funds. If you're self-employed, you're responsible for both parts, making your effective Social Security tax rate 12.4%.
For Medicare, the tax rate is just 1.45%. However, there's no limit on the amount of earned income upon which you have to pay the tax. Again, employers match the tax on their employees' behalf, and self-employed individuals have to pay both portions for a total Medicare tax liability of 2.9%.
Are changes coming to payroll tax withholding?
Tax increases are rarely popular. However, when it comes to Social Security and Medicare taxes, some policymakers believe that there's an opportunity to change the payroll tax withholding system in a way that will generate more tax revenue.
Many policymakers dislike the way in which Social Security payroll taxes get charged. It's a regressive tax, meaning that lower-income individuals pay the full percentage amount of the tax. Meanwhile, those who earn more than the Social Security wage-base cap stop having to pay Social Security tax after a certain point each year.
To make things fairer, some lawmakers have suggested either imposing an additional Social Security tax on earnings above a certain amount, or simply eliminating the wage base limit entirely. On the positive side, increases in revenue would be able to fund expanded benefits for many Social Security recipients, especially those who had relatively low career earnings and who therefore rely more on Social Security for their well-being in retirement. More urgently, the program's trust fund is expected to run out of money in 2034. The SSA projects that, at that point, annual revenues will only be sufficient to pay about three-quarters of what's owed to beneficiaries, which would mean benefit cuts. Lifting the wage base cap to increase revenues is one of the most commonly suggested solutions that would allow Social Security to avoid cutting retirees' benefits.
Critics of the plan, however, argue that those who would have to pay more in taxes would get little or no additional benefit for themselves, essentially turning the Social Security system into a pure wealth redistribution mechanism rather than a social insurance system.
Currently, with different political parties controlling the White House and Congress, no changes to the system of imposing Social Security and Medicare payroll taxes on earnings are likely. Nevertheless, as the 2016 election campaign continues, you can expect to hear more political rhetoric about the programs and their impact on your take-home pay.
Figuring out your payroll taxes for Social Security and Medicare can be challenging, especially given the way in which caps on the Social Security tax, the lack of a Medicare payroll tax limit, and their combined treatment under FICA all interact together. Nevertheless, knowing the basics will help you understand better where all your hard-earned money is going when it gets taken out of your paycheck.
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