Do You Pay Medicare Tax on 401(k) Distributions?
Clarify the tax treatment of 401(k) distributions concerning Medicare tax. Learn how retirement income is generally assessed.
Retirement planning involves understanding how Medicare taxes apply to income received in retirement. This article explores the relationship between Medicare tax and your 401(k) distributions, which is important for financial planning.
Understanding Medicare Tax
Medicare tax is a federal payroll tax designed to fund Medicare Part A. This tax is a component of Federal Insurance Contributions Act (FICA) taxes, which also include Social Security taxes. Employees and employers share this tax burden.
For employees, the Medicare tax rate is 1.45% of all covered earnings, with employers contributing an additional 1.45%, for a total of 2.9%. There is no wage base limit for Medicare tax, meaning all earned income is subject to it. Self-employed individuals pay both the employee and employer portions, totaling 2.9% on their net earnings. An Additional Medicare Tax of 0.9% applies to individual wages or self-employment income exceeding certain thresholds, such as $200,000 for single filers or $250,000 for married couples filing jointly.
How 401(k) Distributions Are Generally Taxed
The tax treatment of 401(k) distributions depends on whether contributions were made on a pre-tax or after-tax basis. Traditional 401(k) plans are funded with pre-tax contributions, meaning the money grows tax-deferred until retirement. Distributions from a traditional 401(k) are generally taxed as ordinary income.
Roth 401(k) contributions are made with after-tax dollars. While there is no upfront tax deduction, qualified distributions in retirement are entirely tax-free. For a distribution to be qualified, the account must have been open for at least five years, and the account holder must be age 59½ or older, disabled, or deceased. The income tax implications of 401(k) distributions are distinct from Medicare tax considerations.
Medicare Tax and Your 401(k) Distributions
Distributions from a 401(k) plan are generally not subject to Medicare tax. Medicare tax is levied on “wages” and “self-employment income.” While 401(k) distributions are considered ordinary income for federal income tax purposes, they are not classified as wages or self-employment income subject to FICA taxes.
This is distinct from the Net Investment Income Tax (NIIT), a separate 3.8% surtax. The NIIT applies to certain net investment income for high-income individuals, including interest, dividends, capital gains, and rental and royalty income. However, distributions from qualified retirement plans like 401(k)s and IRAs are excluded from the definition of “net investment income” for NIIT purposes. This means your 401(k) distributions are not directly subject to the 3.8% NIIT, even if your overall income is high.
Other Retirement Income and Medicare Tax
The principle that Medicare tax applies to wages and self-employment income extends to other forms of retirement income. Distributions from traditional Individual Retirement Accounts (IRAs) are treated similarly to traditional 401(k) distributions; they are subject to federal income tax but not to Medicare tax.
For Roth IRAs, qualified distributions are tax-free and not considered taxable income. Consequently, they are also not subject to Medicare tax. Social Security benefits also follow this pattern; they are exempt from Medicare tax. While a portion of Social Security benefits may be subject to federal income tax if a recipient’s combined income exceeds certain thresholds, this income tax is distinct from Medicare tax. Medicare tax is tied to earned income during working years, not to distributions from retirement savings or Social Security benefits.