Why Your Paycheck Is So Much Smaller Than Your Salary
Gross salary? Net salary? FICA? You may notice when you add up a years’ worth of paychecks, the sum doesn’t match your promised salary. Check out some of the reasons these numbers aren’t equal below.
1. Income Tax
Income in the U.S. is taxed at the federal, state and local government levels. The IRS administers federal income tax progressively, meaning rates are determined by income level. Your first income dollar is taxed differently than your highest-income dollar. (You can see which tax bracket you fall into here.) The W-4 form you filed when you were first hired dictates how much is taken out for the federal government and it is deducted incrementally from each paycheck. (You may owe more or less than this estimate and thus may get a tax bill or refund come tax time.) State and local taxes vary based on location but also can be deducted from your paycheck.
2. Social Security
To help you cope with loss of regular income in retirement, the federal government requires employers to withhold a certain percentage (currently 6.2% from both employee and employer) of employee paychecks for Social Security benefits. The Social Security Administration takes the average of your highest-earning 35 years of covered wages, indexes for inflation and provides you with some income in the form of benefits.
Similar to Social Security, Medicare withholdings are mandatory. These taxes go toward the Medicare insurance that you will qualify for once you are 65. Both employer and employee pay 1.45% of gross income into the system on the employee’s behalf and it provides coverage for major medical expenses. As of 2013, there is an additional tax for those with $200,000 of annual income or more.
4. Retirement Contributions
Plans like 401(k)s and 403(b)s are tax-deferred through your employer. These contributions can be taken directly out of your regular paychecks and go toward your retirement savings. The more you assign toward these accounts, the lower your federal income tax withholding will be.
5. Insurance Deductions
Health care (like medical and dental) and life insurance premiums paid through your employer are taken out at payroll as a deduction. Your health insurance premiums are not subject to FICA or Medicare taxes.
Even though your net income may not be all you hoped for when you got your salary statement, it is important to know where that money is going and how it may help you in the future.