Starting your first job is an exciting time. However, once you take a look at the numbers, you might be surprised to discover that you’re not taking home as much as you thought.
A look at your paystub shows a number of paycheck deductions that reduce your total take-home pay. Here’s what you need to know about the taxes deducted from a paycheck, as well as other deductions you might see.
What are deductions on a paycheck?
First of all, it’s important to understand what deductions on a paycheck are. Your paycheck deductions items that your employer manages for you. They take money out of your earnings and then redirect the money for other purposes.
For example, the taxes deducted from your paycheck are what you’d pay to the federal government, and your employer generally handles that transaction. If there are other items, such as retirement savings or health insurance premiums, they are also handled by your employer. The company payroll office does the administrative work of taking the money from your paycheck and then depositing it in your retirement account or paying your health insurance premium.
The money you earn before deductions on a paycheck is your gross earnings. After deductions are taken, the remainder is called your net pay, or take-home pay.
Taxes deducted from your paycheck
Although it isn’t always fun, paying taxes is mandatory. Depending on where you live, there may also be state tax deductions on top of your federal tax deductions.
Federal tax paycheck deductions
The United States levies an income tax, so a percentage of your income, based on your salary, is deducted from each paycheck. However, the amount deducted for your income is impacted by the information on your W-4, which you normally fill out during the onboarding process of a new job.
Filling out the W-4 accurately can be a difficult line to walk, since you want to make sure you’re not withholding too much and therefore reducing the amount on your paycheck, but you also want to make sure you’re withholding enough that you won’t be stuck with a tax bill at the end of the year.
Other federal deductions from your paycheck include withholdings for Social Security and Medicare. These withholdings are known as FICA or payroll taxes. Everything pays a flat percentage of their income for these taxes. You pay half the tax and your employer pays the other half.
State and local tax paycheck deductions
When looking at the deductions on your paycheck, you might also see state and local taxes. Some states levy income taxes, and there might also be income taxes for individual counties and cities. Your paycheck deductions include those amounts.
Additionally, you might end up paying other taxes, such as short-term disability, depending on the types of taxes and programs in your state. Read through your pay stub to see what taxes you’re paying and talk to your payroll officer or human resources department if you have questions.
Tax-advantaged account contributions
In addition to taxes deducted from your paycheck, you also maximize your money through certain voluntary deductions. Depending on your employer, you can elect to have some of your money directed to tax-advantaged accounts, including investment accounts.
Retirement account contributions
One of the best ways to save for retirement is to make your retirement contributions automatic through a paycheck deduction. Money is taken from your paycheck and redirected to a tax-advantaged retirement account. You decide how much is taken from your pay and used to invest in your future. Contributions can be:
- Pre-tax: A traditional 401(k) and other traditional retirement accounts deduct your contributions before taxes are figured. So, if you’re set up to contribute $3,500 per year and your salary is $40,000, your taxes will be taken as if you’re making $36,500. It lowers your tax bill today. You do have to pay taxes on the money when you take it from your retirement account later, though.
- After-tax: Some accounts, such as Roth accounts, that don’t offer a tax benefit on the front end. However, you won’t have to pay taxes on the money when you withdraw it later.
Consider what makes sense for you, and what’s offered by your employer, to determine how to deduct your retirement contributions from your paycheck. Keep in mind that some employers will match a percentage of your retirement contributions, which can be a fantastic financial option. That’s free money to fuel your investment returns.
Health Savings Account contributions
If your employer offers a Health Savings Account (HSA) option, you might be able to set aside tax-advantaged money for healthcare costs today and in the future. Your HSA contributions are taken from your paycheck before taxes are figured, so you can further reduce your taxable income and save money on your bill.
Many HSAs also provide the ability to invest funds, so you can use the HSA as a way to grow your healthcare dollars more efficiently. Plus, some employers offer a match on a percentage of HSA contributions, giving you an extra boost.
Other employee benefits deducted from your paycheck
Depending on your employer, you might have access to other employee benefits that can then be deducted from your paycheck.
One of the biggest deductions is health insurance premiums. If your employer offers access to a health plan, you might be responsible for a portion of the premium. That amount is deducted from your paycheck and used to pay the insurance company. Then, when you need services, you just show your insurance card and make the appropriate co-pay.
Other benefits that might be taken from your paycheck, depending on the employer and what’s offered, include:
- Spending accounts, including Flexible Spending Accounts (FSA) for healthcare costs. Additionally, there are some accounts that allow for spending on dependent care costs. Both types of pre-tax accounts are use-it-or-lose-it, so you need to spend the money in the year it’s saved.
- Commuter benefits, such as the ability to pay for parking and public transit. These benefits are often pre-tax.
- Insurance, including disability and life insurance premiums. Some employers offer you the ability to purchase amounts of life and disability insurance, which can help protect your family and income with an automatic premium payment from your paycheck.
- Gym membership to a local fitness facility, usually at a discounted rate.
Even though your take-home earnings can seem small after all the paycheck deductions, if you carefully consider what they’re used for and maximize them, you might get good value in the future.