What are FICA taxes and pre-tax savings? A guide to FICA taxes, HSAs, FSA, and more

Pre-tax savings. Post-tax savings. And what are these taxes anyway? Understanding the taxes for health savings accounts (HSAs), flexible spending accounts (FSAs), and other benefits plans can be time-consuming and difficult to explain to employees who might wonder how pre-tax savings works. 

Pre-tax savings are tied directly to FICA taxes. So what is FICA? And how do the pre-tax savings work for your employees’ HSAs and FSAs? Let’s break down these concepts and explore how they impact both you and your employees.

What is FICA?

FICA, or the Federal Insurance Contributions Act, is a federal payroll tax that funds two major government programs: social security and Medicare. These taxes are withheld from employees’ wages to provide retirement, disability, and healthcare benefits. 

What is the FICA withdrawal breakdown of social security versus Medicare?

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

What are the FICA tax implications for employers and employees?

Employers shoulder various responsibilities when it comes to FICA taxes:

• 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 to offer them? 

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 these agreements are in place, the allocated contribution amount is deducted from your employees’ paychecks before funds are taxed. This early deduction is critical because it directly reduces their taxable income.
3. Realizing FICA tax savings: By channeling funds into HSAs and FSAs with pre-tax dollars, both you and your employees stand to benefit because you’re reducing your 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 your employees have funds readily available for qualified medical expenses.

What are some other benefits to FSAs and HSAs? 

FSAs:

• Upfront funds: Employees can elect a portion of their pre-tax income 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.

Want to learn more about FICA taxes? Check out our infographic! 

The information in this blog post is for educational purposes only. It is not legal or tax advice. For legal or tax advice, you should consult your own legal counsel, tax and investment advisers. 

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