How to Read Your Paycheck: A Guide to Deductions, Withholdings & Gross Pay vs. Net Pay

If there’s one thing we can all agree on, it’s this: Everyone loves pay day. 

Yet, even if that initial boost to your bank account feels awesome (you can even get paid up to two days early if you’re a Chime member), have you ever taken a look at what you’re actually paid vs. what’s taken out of your paycheck in deductions? Have you considered how these payroll deductions affect your money situation? 

Read on to learn how to read your paycheck. 

Gross Pay vs. Net Pay  

Let’s dive into some terms you might see. For starters, what is gross pay and net pay? 

Your gross pay is what you get paid before all of the deductions are taken out. You can consider your annual salary your gross pay. So, if you were offered a job with a $65,000 salary, that’s your gross pay. 

But that’s not what you take home at the end of the day. After all, there are taxes and other deductions that take a bite out of your paycheck. And here is where we arrive at your net pay.

Net pay refers to the amount you get paid after all the deductions are taken out. So, net pay is the actual number that gets deposited into your bank account

It’s important to know the difference between gross and net pay as this can affect how you spend and save money. For example, you might be spending based on your gross pay but it’s probably a better idea to base your budget and spending on your net pay, which is what you’re actually taking home. 

Tax Withholdings: How Gross Pay Becomes Net Pay

Do you remember when you first got hired and had to fill out a W-4 form and choose your tax withholding? 

It may be confusing, but what goes on that W-4 form determines how much gets taken out of your paycheck for taxes

Some typical deductions on your paycheck include:

  • Federal tax
  • State and local tax
  • Social Security and Medicare tax 

Let’s take a deeper look. 

  • Federal Income Tax  

If you’re an employee in the United States, you’re required to pay federal income tax. Federal income tax is a pay-as-you-go arrangement, so a portion is taken out with each paycheck. The amount deducted depends on your tax bracket as well the tax withholding you elected on your tax form. 

There are seven different federal income tax rates:

Tax Brackets and Rates 2019 by Tax Foundation
       Source: Tax Foundation

As you can see, how much you earn and whether you’re single or married will affect the amount of taxes deducted.

  • State Income Tax

It’s not just the federal government that wants a slice of your paycheck. Your state also has a state income tax that is taken out of your paycheck. 

Some states have a flat tax rate that doesn’t change regardless of your income. Other states, like Washington and Texas, have no state income tax at all. Still, other states have a graduated tax rate which is similar to the federal tax bracket breakdown. 

  • Federal Insurance Contributions Act (FICA): Social Security Tax & Medicare Tax

When you look at your paycheck you might see FICA and wonder what that acronym is. 

FICA stands for Federal Insurance Contributions Act, which includes social security tax and medicare tax. Employers are required by law to take out these deductions. 

The Social Security tax is something that you pay into and can use upon retirement. It’s also available if you become disabled. The Social Security tax rate is 12.4 percent and your employer pays half and you pay half, so your contribution is 6.2 percent. 

Medicare provides healthcare after age 65 or if you have a disability. The Medicare Tax rate is 2.9 percent and you and your employer each pay half, so your contribution is 1.45 percent. 

Employee Benefits Deductions 

We’ve covered the mandatory deductions that are taken out of your paycheck, but there may be other deductions that you opt into as well. For example, if you take advantage of your employer-sponsored retirement plan, you may see your 401(k) contributions deducted as well. 

Here are some common employee deductions. 

  • Health Insurance

Your employer may offer health insurance and you may have some of these deductions taken out of your paycheck to pay for your health coverage. For example, you might have separate line items for medical, vision and dental.  

  • 401(K) Retirement Savings 

In a nutshell, a 401(k) is an employer-sponsored retirement plan that is only available through your workplace. This can make it easier for you to save for retirement. Your 401(k) contributions are also tax deductible, which can lower your tax liability and save you money on taxes. 

  • Flex Spending & Health Savings Accounts 

At your job, you might be eligible for flex spending and health savings accounts. 

  1. A Flexible Spending Account (FSA) allows you to make tax-free contributions for out-of-pocket health costs. Your employer may contribute to the FSA but it is not obligated to do so. You typically must use your FSA funds within that same year. 
  2. A Health Savings Account (HSA), on the other hand, lets you save money on a pre-tax basis to pay for certain medical expenses like deductibles, co-payments, and more. The one caveat here is that you must have a High Deductible Health Plan (HDHP) to be eligible for an HSA. 

This is How Chime Gets You Paid Early

Why it’s Important to Understand Your Income Taxes & Employee Benefit Deductions 

Let’s face it: When payday comes, you’re probably excited for the cash. But it’s important to understand your income taxes and deductions. 

Having an understanding of how your paycheck works also makes you more financially literate and empowered. This will help you track your income more accurately, which will help you budget and save. Also, if something looks awry on your paycheck – because mistakes can happen – you can fix it. This way nothing will come between you and your money. 

Hourly Employees & Overtime Hours 

If you’re an hourly employee, it’s important to track your hours and make sure you’re getting paid for all the time you’ve worked. If you are eligible for overtime, make sure you know the policy and track those hours, too. 

Pay Stub Glossary: 13 Common Terms to Understand When Reading Your Paycheck 

There are several common terms that you might see on your pay stub. Below are some of these terms, along with their definitions. Take a look:  

1. Pay Period 

A pay period refers to the amount of time between one payroll run and the next. So, if you have a pay period from the 1st to the 15th of the month, you should be paid for all hours worked during that time. 

2. Withholding 

Withholding or withholding tax refers to money that is withheld from your check to be paid to the government. 

3. Deduction 

A deduction is an amount of money that is subtracted from your gross income, which can lower your tax liability. In other words, a deduction can lower the amount you pay in taxes. 

4. Bi-monthly paychecks 

Bi-monthly paychecks refer to getting paid twice a month, typically on the 15th and the last day of the month. 

5. Bi-weekly paychecks 

Bi-weekly paychecks refer to getting paid every other week.

6. Hourly Pay

Hourly pay refers to the amount of money you are paid for each hour worked. 

7. Salaried Pay 

Salaried pay refers to the total amount of money you’ll make for your work. If you have salaried pay, you typically get paid the same amount regardless of how much you work. 

8. YTD

YTD refers to Year to Date, which shows you how much you’ve earned at the start of the calendar year until the current date. 

9. Progressive Tax Rate 

A progressive tax rate refers to tax rates that go up gradually based on income. So, low income earners pay a lower tax rate compared to those who earn higher incomes. 

10. FT

FT refers to Federal Tax, or the taxes that the federal government take out of your paycheck. 

11. ST

ST refers to state tax, which refers to the taxes that your state takes out of your paycheck. State tax rates vary by state and not all states have state income tax. 

12. SS

SS refers to Social Security, which is a tax that goes toward retirement benefits for your future. 

13. MTW

MTW refers to Medicare Tax Withholding and is a tax that is taken out to provide insurance in your elderly years. 

Be your own financial advocate 

Now that you know the terminology and how to read your paycheck, you can take steps to manage your money and be your own financial advocate. Isn’t it about time you make sure you’re getting paid the right amount? 

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