Do You Pay FICA Tax on Pension Income?
Retirement distributions are taxed differently than wages. Learn how tax law applies to your pension to help manage your financial obligations.
Navigating the tax implications of retirement income can be a source of confusion for many retirees. The rules governing different income streams, such as pensions, vary significantly from the payroll taxes experienced during one’s working years. Understanding these distinctions is a fundamental part of managing finances in retirement.
FICA Tax on Pension Income
Pension distributions are generally not subject to Federal Insurance Contributions Act (FICA) taxes. FICA is a U.S. federal payroll tax composed of two separate taxes: a 6.2% Social Security tax and a 1.45% Medicare tax, paid by both employees and employers on earnings. The reason for this exemption is that FICA is a tax on wages for services, while pension payments are classified as distributions from a retirement plan.
The distinction lies in when the tax was paid. For most retirement accounts, including traditional pensions and 401(k)s, the contributions were made from paychecks that had already been subjected to FICA taxes. Taxing these funds again upon withdrawal in retirement would amount to double taxation for the same purpose.
This rule applies broadly to various forms of retirement income, including payments from pensions, annuity distributions, and withdrawals from IRAs or 401(k)s. The Social Security Administration does not view pension payments as earned income, meaning they do not count toward your earnings record for calculating future Social Security benefits.
Federal Income Tax on Pension Income
While pension income escapes FICA taxes, it is typically subject to federal income tax. The Internal Revenue Service (IRS) views most pension payouts as ordinary income for the year in which you receive them. This means the funds are taxed at your regular marginal income tax rate, similar to how your salary was taxed during your working years.
Retirees will receive a Form 1099-R from their pension plan administrator each year. This form reports the total amount of the pension distributed during the year and details how much of it is taxable. It will also show the amount of any federal or state income tax that was already withheld from the payments.
To manage this tax liability, retirees have the option to request voluntary tax withholding from their pension checks. By filling out a Form W-4P, “Withholding Certificate for Pension or Annuity Payments,” you can instruct the payer to withhold a specific amount or percentage for federal income taxes. This proactive step helps in avoiding a large, unexpected tax bill when filing an annual tax return and can prevent potential underpayment penalties.
Taxation of Social Security Benefits
Similar to pensions, Social Security benefits are not subject to FICA taxes. The contributions you made via FICA taxes during your working years were specifically to fund this program, so the benefits you receive are not taxed for that same purpose again.
A portion of your Social Security benefits may, however, be subject to federal income tax. The taxability depends on your “combined income,” which is also referred to as your provisional income. This figure is calculated by adding your adjusted gross income (AGI), any nontaxable interest you received, and one-half of your total Social Security benefits for the year.
If your combined income as a single filer is between $25,000 and $34,000, up to 50% of your benefits may be taxable. For those married filing jointly, that same 50% taxability applies to a combined income between $32,000 and $44,000. If your income exceeds these upper thresholds, up to 85% of your Social Security benefits could be subject to federal income tax.