Do you want to make sure your knowledge of Medicare and what it means for retirees is up to date?
If you are not signed up for Medicare yet, and you are close to retiring, a lot of advice given to you is to sign up when you turn 65. However, not everyone talks about Medicare taxes when they give that piece of advice. While during the time we are employed, we have all seen the deducted FICA tax from our paychecks, not everyone stops to ask themselves what it is for and how Medicare comes into play here.
The Federal Insurance Contributions Act (FICA) is part of the federal payroll tax that goes towards funding for both Social Security benefits and Medicare, which are going to provide extra benefits for children, those who are disabled, and retirees. A big question that many people have is whether or not, once you are retired, you will have to keep paying Medicare taxes from your retirement income.
After all, once you are retired, your income switches to retirement benefits, investment income, or just your savings, so it is really important to know this information. While you will be relieved to learn that you are no longer required to pay FICA or Medicare taxes in general, there are some exceptions.
In order to best understand what is up with Medicare taxes, who has to pay, and how much, we have gathered the most pressing questions and explained everything you need to know about them to hopefully clear up any misunderstandings and help you better understand these taxes!
What are Medicare taxes?
The first step towards understanding what and why you are being taxed is to know your taxes well. This is also true when it comes to hospital taxes, and the Medicare tax is essential for just that.
Also known as the “hospital insurance tax,” this part of the federal tax problem is applicable to employed individuals and makes sure that a part of the money they receive from taxes goes toward the Medicare insurance program. Much like the Social Security tax, it is not something that you have to pay every tax season separately but rather is withheld each month from the employee’s paycheck or, if you are self-employed, it is paid with the self-employment tax.
This tax covered part of the Medicare program, which allows people who are 65 or older (retired or not) and those who are suffering from certain medical conditions or disabilities access to hospital insurance. This insurance will cover their hospice or nursing home care, hospital visits, and some of their home healthcare.
For this reason, all retirement-aged people are encouraged to sign up for Medicare as part of their healthcare expenses will be covered.
How Does Medicare taxing work?
Everyone who works in the United States will end up paying Medicare taxes as they are part of the FICA taxes that employers are required by federal law to withhold and pay to the state from their employees’ paychecks. This is a part of the money that the employee will not see physically, but on their payslip, all the money that was withheld and paid towards federal taxes (including Medicare and Social Security benefits) will be written down there.
All the money that the state collects through this taxation scheme is gathered and put into trust funds under the U.S. Treasury, more specifically into the Hospital Insurance Trust Fund. The money from this fund is then used to pay for Medicare Part A, which covers all the medical expenses we talked about before. The rest of Medicare is funded by other types of taxes.
2022 Tax Rates for Medicare
For the 2022 tax year, the Medicare tax rate is going to be 2.9%, but this one is split between employers and employees! This means that the W-2 employee has 1.45% of their paycheck going towards the tax, while their employer will cover the remaining 1.45% when they pay the federal tax that month. In the case where you are self-employed, this split cannot happen with your employer since you are on your own, so the person will have to cover the entirety of the 2.9% rate themselves.
When compared to the Social Security tax, the Medicare tax does not have an income limit to which it is applied. All the income that you make throughout your employment is going to be taxed.
What’s the role of the Affordable Care Act (ACA)?
You may have heard of the Additional Medicare Tax or the Surtax on Medicare. It is not something that all people have to pay, so there is no need to think that you have been taxed extra. The Affordable Care Act (ACA) was passed back in January 2012, and it introduced an extra tax for Medicare that would be applicable to people who are known to be high earners.
Thus, if your income had been over $200,000 (or over $250,000 for a married couple filing jointly), then you would have had to pay extra taxes (of 0.9%) beyond the standard for the extra income over the threshold. This doesn’t mean that you would have to pay the extra tax for your whole income; you will pay the normal tax for the first $200,000, and then the rest of the $50,000 will be taxed extra. That extra is the responsibility of the employee only, with no input from the employer.
Now let’s talk about how this tax impacts retirees, if it is applicable at all!
Is there a correlation between Medicare taxes and investment income?
Once you have retired, your income will generally come from the savings you have accumulated over the years, pension benefits, and social security benefits (if they are applicable to your situation). While the Social Security benefits are going to be taxed under the income tax even in retirement (depending on where you live), the rest of your income is generally not going to be subject to FICA or Medicare taxes.
Thus, annuities, pension payments, and other interest or dividends you may be receiving from your investments or from your savings are not going to be subject to the Medicare tax. Any contribution to traditional retirement accounts, like the 401(k) or IRA, has already been subject to the FICA tax when you earned the money, so it would make no sense for you to keep paying when making withdrawals.
Another piece of good news is that if your employer used to match your 401(k) contributions, those funds were never subject to these taxes!
What about Severance Pay?
You may be wondering what happens if you are retired but entitled to receive some benefits like severance pay. To refresh your memory, severance pay is a benefits package and pay that an employee may receive if they are made to unwillingly leave their workplace. This type of pay is taxable if you are receiving it, so even if you are retired and still receiving these benefits, you will have to pay taxes on this income. This includes the Medicare tax.
Yet, if the company you have been working for has filed for bankruptcy and this is the reason you have been laid off, then according to the 2021 Sixth Circuit Court rules, your severance pay will not be subject to the FICA taxes at all.
Is Deferred Compensation affected by these taxes?
On the other hand, if you are not entitled to severance pay, you may be in a situation where you are receiving different compensation. These deferred compensations are when people receive their salary at a later date. It may happen that you receive this compensation after you have already retired. While it will not be taxed right away, the tax will not be applied right then and there, but you will have to pay it. This includes income taxes, Social Security, and Medicare taxes!
Even if you are retired, you have to prepare yourself for a pretty big tax bill. For example, if your employer has set aside $10,000 of your annual salary to be given in deferred compensation, the year you will be receiving that whole amount, you will have to pay taxes on that full amount out of your own pocket. If you worked for them for ten years, you would be paid $100,000, but you would also be subject to income and FICA taxes on the entire amount!
Make sure to check your plan because you may be able to structure your payments over a longer period instead of having to pay those taxes as a lump sum!
When do retirees have to pay Medicare taxes?
Unfortunately, your age is not a factor in whether or not you will be paying Medicare taxes. Even if you are over the age of retirement, but you have decided to keep on working part-time, the income you will be earning will still be subject to income taxes, and thus FICA ones as well. If you decide to open your own business in retirement, you will have to pay more FICA taxes as you will be self-employed and will have to pay it in full, with no employer to match your tax rate.
Whichever situation you may be in, you should consider polishing up on your knowledge of taxes and preparing an estimate of how much you will owe to the state each year. It may also be a good idea to talk with a financial advisor if you cannot make heads or tails of the subject. It’s better to ask for help than to end up being confused.
And since we have been talking about making sure we know all that there is about a certain topic, make sure you avoid making these Social Security Benefits mistakes so you can spend your golden years in peace!
When taking the Required Minimum from your IRA there is an advantage to donate all the amount you are required to take directly to charity. This reduces the tax you pay on your Social Security. We have been doing this for the past several years. However, we cannot claim it as contributions on the long form. This should also be mentioned to others. It will help charities and also help the taxpayer.