Do You Qualify for a FICA Alternative Retirement Plan?
Which type of retirement account is right for you? Money Girl answers a voicemail question about using a FICA Alternative Plan, choosing the right retirement plan, and reaching your financial goals. Plus, you’ll get an explainer about all those payroll taxes deducted from your paychecks.
Laura Adams, MBA
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Do You Qualify for a FICA Alternative Retirement Plan?
A voicemail caller named Jamie says, “I have a mandatory Social Security alternative plan at work where I save about 7 percent. But my goal is to save a total of 15 percent for retirement. Does that mean I should save 15 percent on top of what I’m putting into my existing plan?
Also, I can choose a 457(b) or a 403(b), which both come with a Roth option. Can you explain which type of retirement account would be more beneficial?”
Thanks for your question, Jamie! In this post, I’ll explain what a Social Security alternative plan is, who qualifies for one, and the differences between a 457(b) and a 403(b).
What Is a FICA Alternative Plan?
A Social Security Alternative Plan is more commonly called a FICA Alternative Plan or a FICA Replacement Plan. It’s a private retirement account created for certain workers who are temporary, part-time, or employed by the government and are not eligible to pay into the Social Security system.
Other employees are required to fund the Social Security system by paying FICA payroll taxes, which I’ll explain in a moment. Employers must deduct these taxes from your paychecks and send them to the government on your behalf.
So, think of a FICA plan as a substitute when you don’t pay Social Security taxes. Instead, you’re required to contribute a minimum of 7.5 percent of your wages to a FICA plan account.
Think of a FICA plan as a substitute when you don’t pay Social Security taxes. Instead, you’re required to contribute a minimum of 7.5 percent of your wages to a FICA plan account.
Contributions to a FICA Alternative Plan can come from an employee, employer, or both. It sounds like Jamie is putting in the entire 7.5 percent on her own, which is the most common scenario.
No matter who funds a FICA alternative plan, the employee owns it and controls how the funds are invested. If you leave your employer or move to a position that makes you ineligible for a FICA alternative plan, you can always take the money with you.
Since Jamie’s goal is to save fifteen percent for retirement, one option that her FICA plan may allow is to raise her contribution from 7.5 percent to fifteen percent. Another option is to also contribute 7.5 percent of her income to another retirement account, such as a Roth IRA.
What Is FICA?
Let’s back up for a brief explainer of FICA. FICA stands for the Federal Insurance Contributions Act. This law mandates the Social Security and Medicare taxes that are deducted from many workers’ wages.
Most employees fund these programs by paying FICA tax of 7.65 percent up to a certain amount of earned income. What many people don’t realize is that you pay a portion and your employer must pay a matching portion as well, for a total of 15.3 percent.
The money you pay for social programs is not set aside for you in an individual account; your funds are pooled for the government to manage. Once you retire, the workforce continues to fund Social Security and Medicare while you receive the benefits.
The idea is that you and your employer contribute to social programs throughout your career. And by the way, if you’re self-employed, you must pay the entire 15.3 percent, which is known as the self-employment tax.
The money you pay for social programs is not set aside for you in an individual account; your funds are pooled for the government to manage. Once you retire, the workforce continues to fund Social Security and Medicare while you receive the benefits.
What Is the Social Security Tax?
You can collect Social Security retirement as early as age 62. But waiting until your full retirement age (which is 67 for most workers) or delaying retirement until age 70 means that you’ll receive a larger monthly benefit.
For 2019, the Social Security tax makes up 6.2 percent of the FICA total tax, which is 7.65 percent, as I previously mentioned. But you don’t pay Social Security tax on all your income because there’s a wage threshold of $132,900.
Once your earnings exceed $132,900 during the year, no additional tax is deducted from your pay. In other words, no one pays more than $8,240 ($132,900 x .062) of Social Security tax per year. However, the wage threshold typically goes up each year.
Because the Social Security system may run out of money in future decades, we’re likely to see the payroll tax increase, the wage base threshold go up, or both, in order to keep the program financially healthy.
What Is the Medicare Tax?
For 2019, the Medicare tax portion of FICA is 1.45 percent. However, high earners must pay more. Wages paid in excess of $200,000 for single taxpayers or $250,000 for married couples who file taxes jointly are subject to an additional 0.9 percent, bringing the total up to 2.35 percent.
You’re eligible for Medicare health benefits as soon as you reach age 65 (or earlier if you have a qualifying disability).
Differences Between a Traditional and Roth Retirement Plan
Jamie mentioned that she has the option to set up her FICA Alternative Plan as a traditional or a Roth retirement account, using either a 403(b) or a 457(b) plan. But she needs clarification on their differences to know which one would be best for her.
In general, these plans work the same whether you fund them for a FICA Alternative Plan or not. Traditional plans are tax-deferred, which means amounts contributed are not included in your taxable income for the current year. Instead, you pay income tax on distributions taken out in retirement.
Roth plans have the opposite taxation because you don’t get a tax break on contributions in the year you make them. However, any type of Roth account allows you to take withdrawals in retirement that are completely tax-free.
Roth plans have the opposite taxation because you don’t get a tax break on contributions in the year you make them. However, any type of Roth account allows you to take withdrawals in retirement that are completely tax-free. That can add up to massive tax savings!
Unlike a Roth IRA, which isn’t available if your income exceeds certain limits, Roth accounts at work have no income limits or restrictions. You can participate in a Roth 401(k), a Roth 403(b), or a Roth 457(b) no matter how much you earn.
Using a Roth makes sense if any of these apply to you:
- You believe that your income tax rate will be higher in retirement than it is now.
- You don’t need a deduction to reduce your taxes in the current year.
- You have many years to go before retirement.
- You want tax-free withdrawals to diversify your retirement income.
What Is a 403(b) Retirement Plan?
Now, let’s talk about the account types that Jamie can use for her FICA alternative plan, starting with a 403(b). It’s offered by many non-profits, public schools, churches, hospitals, and government agencies. They’re similar to the more well-known 401(k) retirement plan offered by many for-profit companies.
For 2019 (just like with a 401(k), you can contribute up to $19,000, or up to $25,000 if you’re over age 50, to a 403(b). One of the main benefits of having a 403(b) is that if you stay in your job for 15 years, your plan may allow you to save more than these limits, even if you’re younger than 50.
What Is a 457(b) Retirement Plan?
The other type of retirement account available to Jamie is a 457(b). There’s a version offered by state and local government agencies and one with slightly different rules offered by tax-exempt organizations.
For 2019 (just like with a 401(k) and a 403(b)), you can contribute up to $19,000, or up to $25,000 if you’re over age 50, to a 457(b).
One of the main benefits of a 457(b) is that you can make aggressive catch-up contributions starting when you’re three years away from retirement. For example, if your plan specifies 65 as your retirement age, once you reach 62 you can contribute a total of $38,000 for 2019 as long as you earn that much.
Additionally, if an employer offers both a 403(b) and a 457(b), workers may be eligible to max out both plans in the same year. So, my recommendation for Jamie is to split her contributions between both a Roth 403(b) and a Roth 457(b). That will allow her to get the best of both types of retirement accounts available in her FICA Alternative Plan.
For a summary of rules for using different retirement accounts, download the free Retirement Account Comparison Chart. This handy resource spells out everything you need to know on a one-page PDF.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.