Have you ever looked at your paycheck and wondered why the amount deposited in your bank account is so much less than the salary you were offered? The difference lies in a fundamental payroll concept: the journey from gross pay to net pay. Understanding this process is key to managing your personal finances and accurately budgeting.
What is gross pay?
Gross pay is the total amount of money you earn before any deductions or taxes are taken out. This is the figure typically used in job offers and salary negotiations. For a salaried employee, it’s their annual salary divided by the number of pay periods in a year (e.g., a $60,000 salary paid semi-monthly would result in a gross pay of $2,500 per paycheck). For an hourly employee, it’s the number of hours worked multiplied by their hourly rate, including any overtime pay or differentials.
What is net pay?
Net pay, often referred to as “take-home pay,” is the amount of money you actually receive after all taxes and deductions have been subtracted from your gross pay. This is the final amount that gets deposited into your bank account or is printed on your physical check. The equation is simple:
Net pay=gross pay−deductions
The deductions: Where does the money go?
The journey from gross to net pay involves a series of mandatory and voluntary deductions. These are the items that reduce your gross earnings.
1. Mandatory deductions (pre-tax):
These are deductions that are required by law or are taken out before certain taxes are calculated, thereby reducing your taxable income.
- Federal income tax: The amount withheld is based on the information you provided on your W-4 form, including your filing status and any adjustments you’ve made.
- FICA taxes (Social Security and Medicare): These are federal payroll taxes that fund Social Security and Medicare.
- Social Security: A tax of 6.2% on wages up to an annual limit.
- Medicare: A tax of 1.45% on all wages, with an additional 0.9% tax on wages above a certain threshold.
- State and local income tax: Many states and some local governments also have income taxes that are withheld from your paycheck.
- Mandated retirement plan: State Universities Retirement (SURS) plan contributions.
- Health insurance premiums: Your share of the cost for health, dental, or vision insurance.
2. Voluntary deductions (pre-tax):
These are deductions you elect to have taken out of your paycheck. Since they are pre-tax, they lower the amount of income that is subject to federal, and often state, income tax.
- Salary reduction agreements: Employee agrees to have a portion of their salary deducted from their paycheck to be used to pay for qualified parking expenses.
- Retirement contributions: Contributions to a retirement plan, such as a 403(b) or 457 plan.
- Flexible Spending Accounts (FSAs) or Health Savings Accounts (HSAs): Contributions to these accounts are used for health or dependent care expenses.
3. Post-tax deductions:
These are deductions that are taken out after all taxes have been calculated and withheld. They do not reduce your taxable income.
- Roth 403(b)/457 contributions: Contributions to a Roth retirement account are taxed upfront, but qualified withdrawals in retirement are tax-free.
- Garnishments: Court-ordered payments for debts such as child support, unpaid taxes, or student loans.
- Union dues: Dues paid to a labor union.
- Charitable contributions: Donations to a charity through a payroll deduction.
By understanding the difference between your gross and net pay and the various deductions that apply, you can have a more accurate picture of your true take-home earnings. This knowledge empowers you to budget effectively, plan for the future, and ensure your paycheck is correct.
