Seeing your paycheck for the first time is often one of the most exciting parts of having a new job. Unfortunately, the amount may be less than you anticipated. Don't worry—your employer isn't stealing from you (probably).
The reason for this discrepancy is that many people entering the workforce forget about the different deductions and taxes that employers take out of a paycheck. Forfeiting your hard-earned money for these can be a hard idea to swallow at first. But in fact, many regular deductions help when it comes to maintaining your finances.
One mistake people often make is budgeting based on gross income (the amount before deductions) instead of net income (the amount after). To make sure you know how much income will actually end up in your bank account, review these common taxes and deductions before you set up your budget.
This will most likely be the largest piece cut from your paycheck. Federal withholding takes a certain amount out of your wages for income tax. Your yearly federal income tax rate varies based on your income, with different brackets paying different percentages.
When you start a job, your employer will require you to provide complete some basic information, like your name and taxpayer identification number (also known as your Social Security number). At the end of each year, they will submit a W-2 form for you, reporting to the government how much compensation you earned the past year (in wages, tips, etc.). By knowing this amount the IRS can determine what bracket you fall in. The IRS decides the exact boundaries of each bracket every year.
You can change the amount you have withheld by updating your W-4 form with your employer. If you withhold more over the year, you may get smaller paychecks and a potential refund come tax time. If you withhold less, you could take home more each month—and end up with a bill on tax day. Either way, Uncle Sam gets his money. This calculator can help you determine the right approach for you.
As you might have guessed, this is income tax taken by the state, as opposed to the federal government. The rate of withholding will vary from state to state, with some states like Texas and Florida taking no income tax at all from employees.
Employees and employers must both pay Social Security tax. Currently, the Social Security tax rate is evenly split at 6.2% for employees and 6.2% for employers. (If you're self-employed, you're expected to pay the entire 12.4%.) The ceiling to the amount of your income that can be taxed for Social Security in a year is $128,400.
Employees and employers both pay the Medicare tax. The rate is the same for both, currently 1.45%. This rate increases to 2.35% after the first $200,000 people earn annually. (There's no ceiling on the amount of income subject to the Medicare tax.) Collectively, the Medicare and Social Security taxes are known as FICA and may appear on your paystub under that name.
A 401(k) is a common individual retirement plan. With a traditional 401(k), any earnings from your investment—such as interest earned over time—are taxed only when money is taken out of the account.
The idea is to encourage you to save by taxing this income once you've retired, when you may be in a lower tax bracket—which means more money stays with you. If you think you'll be in a higher tax bracket at retirement, you may opt for a Roth 401(k), which take taxes now instead of later.
You must enroll in a 401(k) plan to have this taken out of your paycheck, and the plans will differ from employer to employer. Educate yourself about the specifics each time you start a job. Some companies may offer benefits like matching contributions that will allow you to make the most of your retirement account.
If you wish to use your company's health insurance plan, an amount will likely be deducted from your check to pay for it. The amount varies from company to company and plan to plan, but your company probably offers a few different plans to choose from. Look over your options thoroughly before choosing one, and talk to your human resources representative if you have any questions.
These are just a few common taxes and deductions. You may have other optional deductions to take advantage of, to pay for health-related costs, child care, transportation, and more. Talk to your human resources representative to understand all your choices.
As you start budgeting for your salary, take some time to figure out just how much of your income will be taken out of your paycheck. Not only will you be better equipped to handle your expenses, but you'll also be able to avoid feeling disappointed on payday.