When you first start a job, it’s exciting. You agree on a salary, and you are thrilled that you will soon be getting paid. If your salary is $40,000 a year and you are paid every two weeks, you might be expecting $1,538.46 each check (i.e., your salary divided by 26 pay periods). Unfortunately, this isn’t exactly accurate.
Your gross pay is $1,538.46 each paycheck, but that is the amount you are paid before everything is taken out of your check. And there are several withholdings and deductions that can be taken out of your paycheck before you get what’s left — your net pay.
Withholdings and Deductions
Federal and State Income Tax Withholdings
One of the first things you might notice is that federal and state income taxes are withheld from your paycheck. Income taxes are withheld for the federal government, and, if applicable, for the state and even local governments.
Your income tax withholding is determined when you fill out a W-4 upon being hired with an employer. You claim the number of exemptions you have, and that amount is used to determine how much should be deducted from each check for the federal and state governments. You can also choose to include an extra withdrawal amount for taxes on your W-4. Sometimes, there is a separate worksheet that you can use for state income tax withholding.
If too much money is withheld from your paycheck, you receive a refund after you file your tax return. If you haven’t paid enough, you will need to make up the shortfall — and possibly pay penalties. Many people like to withhold extra to boost their tax refund amounts. However, others argue that this is a bad idea, and you should withhold as little as possible so that you aren’t giving the government an interest-free loan.
You can adjust your tax withholding if you feel you have been keeping out too much or too little.
Social Security Tax and Medicare Tax (FICA) Withholdings
Income taxes aren’t the only monies withheld from your paycheck and passed on to the government. The Federal Insurance Contributions Act (FICA) requires that money be held out of your paycheck for Social Security and Medicare.
The amounts held are 12.4% for Social Security and 2.9% for Medicare. If you work for a more traditional employer, though, you will find that your paycheck isn’t diminished by that much. Your employer pays half your FICA, so your responsibility amounts to 6.2% and 1.45%, respectively.
This money goes toward funding the Social Security and Medicare systems to help you supplement your income and insurance needs when you reach retirement age.
Besides tax withholdings, other items could be deducted from your gross pay. These include things that are more beneficial to you directly. These deductions include:
- Employer-sponsored retirement plan. Contributions to your 401(k) or 403(b) plan come straight out of your paycheck as you instructed.
- Insurance premiums. Health, dental, vision, disability, and life insurance premiums could be deducted your paycheck depending on the options available and your benefit election.
- Flexible Savings Account contributions.
- Direct deposit. Some employers let you automatically deposit some or all of your money into a bank account.
Some of these deductions can be helpful because they can help you reduce your taxable income.
Net Take Home Pay
Your net pay is the amount left after all of the taxes and deductions are subtracted from your paycheck. It might be that your net pay is several hundred dollars less than your gross pay. As a result, your first paycheck can be a little disappointing.
However, as you become used to the situation, you will be able to budget more effectively. Indeed, your budget should be based on your net pay, and not on your gross pay. If you plan based on your gross pay, you will be unable to live within your mean.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own blog at Miranda Marquit.