Almost everything you earn is subject to Social Security and Medicare taxes, and your IRA contributions are no exception. Although the amount you deposit in the account is deductible on your Form 1040, you still have to pay "FICA taxes" -- Social Security and Medicare -- on the money. When you withdraw IRA funds as retirement income, however, you're not paying the Social Security tax on IRA distributions. Some people use IRA money after retiring to delay collecting their Social Security, resulting in a higher monthly Social Security distribution. Using IRA before Social Security won't mean a FICA tax, however.
No Social Security Tax
In most ways, money you take out of your IRA is just like your wages. At the end of the year, the account manager tells you how much you made. You then report the income on your 1040. The big difference is that you don't pay FICA taxes on your IRA withdrawals. That means you don't pay Social Security and Medicare taxes on your IRA withdrawals. Also, you can withdraw as much as you want, and still not owe the FICA taxes.
Tax Efficient Retirement Planning
That's not the case if you earn money on top of your retirement income, however. If you freelance in retirement and earn $10,000, you pay 15.3 percent for Social Security and Medicare, as of 2018. You do want to file Schedule SE, Form 1040, in order to do this. Make sure when you're earning money to consider tax efficient retirement planning.
Whether or not you are earning money when retired, the IRS has some helpful information on retirement tax planning.
FICA taxes came about in 1935 to help fund Social Security, and Medicare taxes were added later. The Social Security payroll tax is for all earned income up to $132,900. Income earned beyond that is not subject to the payroll tax. The Medicare tax is applied to all earned income.
What About A Roth IRA?
Unlike contributions to a traditional IRA, contributions to a Roth IRA are not tax-deductible, but withdrawals are tax-free. As with a traditional IRA, you pay FICA tax on your contributions, but not on your withdrawals. One supposed benefit of a Roth is that if income taxes go up in the future, a Roth comes out ahead of a traditional account: You've already paid taxes at today's rate. If, however, the government raises FICA taxes to support Social Security and Medicaid and leaves income tax rates alone, that advantage disappears.
What About A SEP-IRA?
A SEP-IRA combines the benefits of a workplace retirement plan with an individual retirement account. Your employer sets up an IRA for you, then contributes to it. The money isn't counted as part of your wages, so neither you nor your boss have to pay FICA taxes. When you take money out, all you pay is income tax, just like a regular IRA. The only time FICA comes into play is if you're self-employed and set up an SEP. In that case, you have to pay FICA.
What About a 401K?
You've already paid your FICA taxes when you made your contribution to your 401K, so you don't have to worry about paying again when you withdraw.
What to Know When Filing
While IRA withdrawals aren't subject to Social Security tax, they can make your Social Security benefits taxable. You don't normally pay tax on benefits, but that changes if you have added income. Take half your Social Security income for the year and add it to your adjusted gross income, plus any tax-exempt interest you earn. If you're married and filing a joint return and your total AGI is $32,000 to $44,000, you may have to pay income tax on up to 50 percent of your benefits. If your income is above $44,000, up to 85 percent of your benefits are taxable. Your IRA withdrawals count as part of your AGI. So you'll want to consider that when you decide how much to withdraw from your IRA.
- CNN Money: What is a SEP IRA?
- Social Security Administration: If You are Self-Employed
- Social Security Administration: Benefits Planner: Income Taxes and Your Social Security Benefit
- The Motley Fool: Does an IRA Distribution Count as Income to Social Security?
- Internal Revenue Service: About Schedule SE (Form 1040) Self Employment Tax
- IRS: Retirees: Avoid a Surprise Tax Bill; Get Enough Tax Taken Out of Pension Payments; IRS Withholding Calculator Can Help