What are FICA Taxes and Pre-Tax Savings? A guide to FICA taxes, HSAs, FSA and more

What are pre-tax savings and post-tax savings? Understanding taxes relating to health savings accounts (HSAs), flexible spending accounts (FSAs) and other benefits plans can be time-consuming and difficult to explain. Pre-tax savings are tied directly to FICA taxes. You may be wondering what FICA is and how does pre-tax savings work for HSAs and FSAs? Let’s break down these concepts and explore how they impact you and your employees.

 

What is FICA?

FICA, also known as the Federal Insurance Contributions Act, is a federal payroll tax that funds Social Security and Medicare. The funds are withheld as a tax on employees’ wages to help provide benefits for those who are disabled, are children or are retired.

 

What is the FICA Withdrawal Breakdown of Social Security Versus Medicare?

• Social Security: A portion of the FICA tax provides benefits for those who are retired, disabled and survivors of eligible workers. The tax rate for social security is 6.2% of an employee’s gross pay.
• Medicare: Medicare taxes support healthcare for individuals aged 65 and older. Both employers and employees contribute a set percentage of 1.45% to Medicare taxes. There is an additional 0.9% tax rate withheld from employees whose individual wages exceed a gross income of $200,000 a year.

 

What are FICA Tax Implications for Employers and Employees?

Employers shoulder various responsibilities when it comes to FICA taxes, such as:

• Withholding: Employers must accurately withhold the correct amount of FICA taxes from their employees’ paychecks, as prescribed by the IRS.
• Matching Contributions: Employers are obligated to match their employees’ social security and Medicare contributions, effectively doubling the overall amount contributed to these programs.

 

How do you Provide Employees with Access to an HSA or FSA Once you Have one?

1. Implement Salary Reduction Agreements: To get started, establish salary reduction agreements with your employees. These agreements allow your workforce to identify a portion of their earnings to be deducted from their paychecks and contributed to an HSA or FSA.
2. Pre-Tax Contributions: Once agreements are in place, the allocated contribution can be deducted from an employees’ paycheck before funds are taxed. An early deduction is critical because it directly reduces their taxable income.
3. Realizing FICA Tax Savings: By directing funds into an HSA or FSA with pre-tax dollars, you and your employees will reduce the FICA tax burden. FICA taxes are typically computed based on taxable wages. Therefore, when contributions to pre-tax accounts increase, the FICA tax burden decreases.
4. A Win-Win Situation: The advantages extend beyond tax savings. Participation in HSAs and FSAs ensures that employees have funds readily available for qualified medical expenses when needed.

 

What are Other Benefits to FSAs and HSAs?

FSAs:

• Upfront Funds: Employees can select a portion of their pre-tax income to be put into an FSA prior to the start of the plan year. FSA funds are immediately available at the start of the plan year for qualified healthcare expenses.
• Tax Savings: Contributions made to FSAs are exempt from federal income, social security and Medicare taxes, translating into potential tax savings for employees.

HSAs:

• Investment Potential: HSAs empower employees to invest their contributions, potentially growing their savings over time. This unique feature positions HSAs as a valuable tool for addressing healthcare expenses during retirement.
• Triple-Tax Savings: HSAs offer a trifecta of tax advantages, including tax-free contributions, tax-free earnings (if invested) and tax-free withdrawals for qualified medical expenses.

 

The information in this blog post is for educational purposes only. It is not investment, legal or tax advice. For legal or tax advice, you should consult your own counsel. To stay up to date on benefits trends and insights, subscribe to our blog.