Understanding Your Pay Stub — How to Make Sense of a Paycheck

Personal finance starts with understanding your paycheck. Why is it less than I thought it’d be? What are all these deductions and withholdings? Understanding your pay stub and getting clear on the taxes and payroll deductions you face will prepare you for a better financial future.
Understanding Your Pay Stub - How to Make Sense of a Paycheck
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We all had the same experience. We were working our very first job and finally, payday came around. We had worked for a number of hours and in our minds we multiplied our pay rate by the hours we worked and we expected to see that number reflected on our paycheck. But then, disaster strikes. We look at our pay stub and the amount of money we’re actually paid is significantly less than what we thought it’d be. We’re outraged. Where did our money go? Why didn’t we make what we thought we did?

This same scenario plays out every day. Of course, after a little experience in the workforce, we begin to understand that all of the money we earn doesn’t actually end up in our account. Along the way, there are deductions, withholdings, and a laundry list of things that siphon off precious dollars from each paycheck.

The purpose of this article is to help each of us understand our pay stub. We’ll go on an in-depth journey into each of those deductions and withholdings so we can learn how to make sense of our paycheck.

Understanding Your Pay Stub - Earnings

So let’s start with the good stuff. The “Earnings” section of your pay stub is where you can see how much you were paid for the current pay period (and typically also see your earnings year-to-date).

Salaried Employees

If you’re a salaried employee, the earnings section should be very straightforward. Rather than show a specific hourly rate and the number of hours you worked, your pay stub will simply display the amount of money owed to you during the pay period.

If you are paid monthly, you will have 12 pay periods throughout the year and your earnings for each pay period will be your total yearly salary divided by 12.

If you are paid bi-weekly, you will have 26 pay periods throughout the year and your earnings for each pay period will be your total yearly salary divided by 26.

These same rules apply if you are paid on a different cadence.

Hourly Employees

If you’re an hourly employee, you’ll see your paycheck calculated based on your hourly rate and the number of hours worked during that pay period.

Additionally, you may also be eligible for overtime pay. In most states, working overtime means making 1.5x or even 2x your normal pay rate. Overtime pay is listed separately in the earnings section to make a distinction between it and regular earnings.

Other Earnings

Beyond regular earnings and overtime earnings, you may also see that you were paid for various other reasons. For example, perhaps you took a paid vacation during the pay period. In this case, you’ll likely see the number of paid vacation hours credited to your earnings. This is also true for other types of paid leave such as sick leave, parental leave, bereavement, etc.

Additional items in the earnings category include things like bonuses and tips.

Understanding Your Pay Stub - Deductions

Now the not so fun part of the paycheck–deductions. This is the area that most people have trouble understanding. Unfortunately, there are often a lot of deductions on our paychecks, so it’s important that we know where that money is going, and why it’s going there.

Payroll Deductions - Taxes

Let’s start with the most common form of deductions which are payroll taxes. Each time we are paid, a portion of our paycheck is deducted to fulfill various tax obligations to the federal, state, and local governments. While certain states may have more or fewer deductions than others, for the purposes of this article, we’ll focus on the most common payroll taxes.

Income Taxes

  • Federal Income Taxes: The money you pay to the federal government based on your wages. When you first join a company, you’ll likely complete a W4 form. This form will dictate how much of your paycheck is withheld for federal income tax purposes.

  • State Income Taxes: The money you pay to your state government based on your wages. Currently (as of Feb 2021), seven states in the union do not levy state income taxes. This includes Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Depending on the state, your federal W4 form may also apply to your state income tax deductions.

  • City/Local Taxes: While more rare, there are certain counties, cities, or school districts  that impose income taxes. These taxes will be withdrawn from your paycheck alongside the federal and state taxes if you live in one of these areas. 

FICA Taxes

FICA stands for the Federal Insurance Contributions Act. FICA taxes incorporate monies withheld for Social Security and Medicare. These taxes are split between employee and employer. Employers are required to match employees’ contributions to FICA taxes.

  • OASDI: This obscure acronym stands for Old Age, Survivors, and Disability Insurance. In other words, this is the tax you pay that goes towards funding America’s social security program. Even for earners who make too little to pay state or federal income taxes, this government collected tax applies to all employees. This tax is collected at a 12.4% rate. This rate is split between employee and employer, so both parties end up paying 6.2% of the employee’s pay to the government.

  • Medicare: This is the tax you pay that goes towards funding America’s Medicare program. Today’s Medicare tax rate is 2.9%. Like the OASDI taxes, the Medicare tax is split between employee and employer. Both parties pay 1.45% of the employee’s earnings to the government. There is no limit on the income that is subject to Medicare taxes. Additionally, the Affordable Care Act added a Medicare surtax (known as the Additional Medicare Tax) for working Americans earning more than $200,000. This is an additional 0.9% tax that is wholly paid by the employee and not split with the employer. The additional tax is only applied to income over $200,000 (so if you make $210,000, the 0.9% tax applies only to the extra $10,000).

Here are four reasons why you should absolutely consider changing your payroll provider.

Payroll Deductions - Withholdings

There are numerous other deductions that may affect the size of your paycheck. Some of these are voluntary deductions. These non-tax related deductions are often referred to as withholdings. Withholdings are used for expenses (like insurance) as well as investments (like 401(k) plans). While we likely won’t cover all of them, here’s a fairly comprehensive list to get you started.

  • Health insurance premiums: Almost 50% of Americans get health insurance benefits through their employer. If you’re one of these, you’ve probably seen a deduction for health insurance premiums on your paycheck. Because the United States has the most expensive healthcare system in the world, these deductions are typically not small.
  • Retirement accounts: Have an IRA, 401(k), or a related retirement plan? If you’re accessing this benefit through your employer, you may see money being withheld from your paycheck to be deposited into this account. Of course, this is only done if you agree to opt-in.
  • Life insurance premiums: Like health insurance, you may also be accessing life insurance through your employer. If this is the case, you’ll see a deduction from your paycheck that goes to providing this benefit.
  • HSA/FSA Contributions: You may have access to a Health Savings Account or a Flexible Spending Account. These accounts help pay for medical expenses with money that is not subject to taxation. By making a direct deposit into one of these accounts, the money will be deducted from your paycheck and deposited into the account without being taxed.
  • Wage garnishments: Garnishments are a collection of unpaid debt. If your wages are being garnished, it is likely due to a court order from the IRS or government collection agency. Wages may be garnished for many reasons such as unpaid taxes, overdue child support, unpaid student loans, delinquent credit card loans, unpaid medical expenses, and more. While income from tips is generally exempt from garnishments, almost every other wage and earning type is eligible to be garnished. You can read more rules and regulations around garnishments here.

Understanding Your Pay Stub - Gross vs Net Wages

The last thing we want to make clear about the numbers on your paycheck is the difference between gross wages and net wages.

  • Gross Wages: This is the total amount of money you are paid before any deductions or withholdings. So, if you’re an hourly worker who gets paid $20/hour and you worked 20 hours during the pay period, your gross wage would equal $400.

  • Net Wages: This is the amount of money that actually finds its way into your bank account after deductions and withholdings. Net wages are often referred to as “take-home pay.” So while your gross wages equal $400, your net wages might resemble something closer to $300.

Conclusion

While we all wish our gross pay and net pay could be equal, it’s important to understand the purpose behind each deduction. Our income taxes, FICA taxes, and other withholdings all play different roles, many of which are critical to the foundation of this country. With a better understanding of your paycheck, we hope you’ll now be able to educate others about the nuances, variables, and surprises we often see when viewing our paystub.

If you’re an employer who has struggled with accurate, affordable payroll solutions, then look no further than Eddy. We are a full-service payroll provider that will help you get the wages, deductions, and withholdings correct for each of your employees every time.

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