Complete Guide to Paycheck Deductions

It can be exciting to get your first paycheck, but it can sometimes be a little bit disappointing when you find out exactly how much you are taking home.

Looking more closely at your paystub or direct deposit slip, you’ll see several line items that are called “deductions.”

Deductions are all of the things that were taken out of your gross pay, leaving you with your net pay, or take-home pay.

While there are some deductions that are required by law and are out of your control, others are part of your employee benefits package, which means that you may be able to adjust them according to what works for you and your budget.

Read on for a paycheck breakdown that can help you understand exactly what is coming out of your paycheck and why.

What is Net Pay?

Whether you’re paid hourly or by salary, your rate of pay is the compensation that you and your employer agreed upon when you accepted the job.

This number appears in official contracts and is referred to as gross pay. However it does not represent the actual amount that will be paid out.

Net pay, also referred to as take-home pay, is the actual amount of compensation that is paid out via check or direct deposit to an employee. It is your gross pay with all the deductions taken out.

By law, an employer must subtract various mandatory federal and state tax withholdings. They will also subtract costs for employer-sponsored offerings that the employee takes part in, such as healthcare, life insurance, and retirement.

Types of Paycheck Deductions

Your pay stub will list all the deductions that are being taken out of your gross pay. Below are some of the most common paycheck deductions explained:

Federal Taxes

Federal taxes include all the taxes you are required by law to pay to the federal government. These taxes help fund the federal government, allowing them to invest in things such as infrastructure, education, and national defense, and provide services to the American people.

When you were first hired, you likely filled out an Employee’s Withholding Certificate or W-4 form form and claimed the number of tax exemptions you have. This amount tells the federal government how much money to take out of each paycheck to cover your taxes. The more allowances you take, the less federal income tax the government will take out of your paycheck.

One way to ensure that you have the right amount of tax withheld for each pay period is to use the IRS Tax Withholding Estimator , or speak with someone in your company’s HR department. You can tell them if you’re single or married, how many dependents you have, and if you have any other sources of income, and they should be able to help you fill out your form accurately.

It’s also a good practice to revisit your W-4 selections annually as significant life events may change your withholding and also because the W-4 form is periodically updated.

During tax season of each year, individuals who have overpaid in federal taxes receive a refund from the government, and those who’ve underpaid are required to pay additional funds, and possibly a penalty.

State and Local Income Taxes

Many states require a state tax to help fund government projects and services, which can range anywhere from 3% to 13%. To learn more about your state’s taxation policy, you can visit the IRS’s Government Sites page and click on your state.

Just as with federal taxes, your state income tax will get deducted from your paycheck to cover taxes you may owe at the end of the year.

Social Security and Medicare

Social Security and Medicare taxes are part of the Federal Insurance Contributions Act (FICA) tax, a group of payroll taxes collected from both the employer and the employee.

The tax rate for social security is currently 6.2%, and Medicare receives an additional 1.45% (employers match these tax rates, bringing the total of FICA tax contributions to 15.3%).

The Social Security and Medicare programs are in place to help with your income and insurance needs once you reach retirement age.

Wage Garnishments

Wage garnishments are legal procedures designed to repay delinquent, outstanding debts, such as unpaid child support, overdue credit card payments, or even unpaid taxes.

Most wage garnishments are initiated by court order, however the IRS and other tax collection agencies also levy for unpaid taxes in the form of wage garnishment.

Garnishments are made on earnings leftover after all legally required deductions are made. The actual amount of any garnishment will depend on the amount of debt owed and income earned.

Employee Benefits

Depending on where you work, you may be able to opt into a variety of benefits, and have these costs automatically deducted from your paycheck.

If you sign up for your employer-provided health insurance, at least some of the cost is likely to come out of your paycheck.

Under the Affordable Care Act, employers with 50 employees or more must offer affordable health insurance. As part of an employee’s compensation package, many companies will pay half, or another percentage, of the insurance premiums. The employee’s portion of those premiums is represented on a pay stub as a deduction.

Other benefits, like flexible spending plans, commuter plans, and life insurance, may also be deducted from your pay, depending on whether or not you opt into them and if your employer picks up the bill fully or partially.

Health insurance and other benefits typically come out before your taxes, and you may be able to reduce your taxable income by signing up for them.

Retirement Contributions

Employee savings plans such as 401(k)s are a common benefit offered in the workforce.

If you opt into this benefit, your employer will deduct funds from your wage earnings and deposit them into a retirement account.

Employees are typically able to choose the amount they would like deducted from their earnings for retirement savings. In some cases, employers may contribute an additional percentage of your salary into your retirement account.

Contributions to your 401(k) not only help you save for the future, but lower your taxable income, since they come out of your paycheck before taxes get assessed.

You’ll want to keep in mind, however, that there are yearly retirement plan contribution limits set by the federal government through the IRS.

The Takeaway

While you may be surprised to see all the deductions coming out of your first paycheck, once you know what number to expect to see landing in your bank account each pay period, you’ll be able to plan your spending and budget accordingly.

It’s a good idea to check your pay stubs periodically to ensure that the deductions being taken out are accurate and align with your financial goals.

If you haven’t maxed out your 401(k) contributions, for example, you may decide to increase them as your income grows and you become more financially stable.

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To make sure the appropriate amount of taxes are being withheld from each paycheck, you may also want to revisit your W-4 annually and make any adjustments as your circumstances change.

Another good way to keep close tabs on your earnings and spending is to sign up for SoFi Money®, which is a mobile-first cash management account.

With SoFi Money, you can earn a competitive interest rate, spend, and save (all in one account), and also track your weekly spending on your dashboard in the app.

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