Do you know why money gets taken out of your paycheck?
If you don’t, you’re not alone. Nearly 64 million people are perplexed by their pay stubs, including half of younger workers, according to a recent study from Kronos Incorporated.
Knowing where your hard-earned money goes can empower you to make smart decisions about taxes, retirement savings, health care and even potential paycheck errors.
Gross vs. Net
Your gross pay is how much money you earned each pay period. It is likely to be quite a bit more than the amount that is actually deposited into your bank account (that’s your net pay).
If you’re an hourly employee you’ll see your per-hour rate as well as any overtime you earned. Salaried workers may see the total annual compensation divided by the number of paychecks you’ll get in the year. You’ll probably also see the number of hours you’ve worked in the pay period.
Most paychecks will also show you your net pay to date (rendered Net YTD). That’s how much money you’ve taken home so far this year. Your net pay — whether annually or for the pay period — is the number you should use when you start a budget.
Until you get up and running at a new job it can be hard to figure out how much will be taken out each week and what you’ll end up taking home. Here’s a calculator to help you estimate your net pay.
Of course, the more information you can provide the more accurate your results will be.
Income tax withholding
Why are your gross pay and net pay different? Uncle Sam shoulders the most blame.
Your employer will hold on to a certain amount of your money for federal, state and local income taxes. The amount held depends on information you provide on one of the first forms you filled out at your new job: your W-4.
The more allowances you have the less tax is withheld. Allowances are determined by your tax status (ie. single, married), the number of jobs you have and whether or not you have dependents. If you’re single with no children and one job, you’ll probably claim one allowance.
If you’re an independent worker or freelancer, taxes aren’t automatically withheld. The responsibility to pay income taxes is totally on you. You’ll need to save up your own money to pay your estimated taxes four times a year.
When you see “FICA,” it means more money has been set aside, put toward Medicare and Social Security.
FICA stands for the Federal Insurance Contributions Act. The Medicare and Social Security parts may be listed individually or together on your paystub.
The Medicare tax goes toward health insurance for those over 65 and people with disabilities. The Social Security money goes into the fund that all working Americans pay into, which provides income for eligible older people and those with disabilities.
The current amount of Medicare pulled from each paycheck is 1.45% and is calculated against all of your earnings. The current amount of Social Security deducted is 6.2%, though it’s capped depending on how much you’re paid. Your employer also pays an equal amount toward Social Security and Medicare.
For independent contractors, you are the employee and the employer so you’ll pay both parts of the taxes, 12.4% for Social Security and 2.9% for Medicare.
To calculate your FICA obligations, use this calculator.
Your company may provide health insurance, but you’re responsible for some of the cost. You also may opt to have part of your paycheck automatically diverted into a retirement plan.
The important thing to understand with money taken for benefits is where you are (and aren’t) taxed.
Health insurance is a perk because the money you contribute toward your health care is not taxable. The money you are contributing to an employer-sponsored 401(k) or other retirement fund is also not subject to income tax withholding. Your employer may also contribute to your fund, which is great — free money! You do not have to pay income or payroll taxes on the employer contribution. But you will need to pay taxes when you take the money out of the fund down the line.