Understanding the Anatomy of Your Paycheck

I’ve been spending more time than usual reading my paycheck lately. It started back in November during open enrollment. I wanted to understand exactly what I was getting deducted from my check and be sure I was taking advantage of the benefits I’d signed up for. Now, a month into 2019, I am able to see what my new elections look like and use that to build my 2019 budget and savings plan.

The Basics

Your paycheck will always have your name, the amount and the date/pay period. It usually will also have your address and maybe some additional contact info like an employee number or phone number. This stuff is good to double check and keep up to date.

Note: If you are a freelancer, it is important to track your invoices and be sure that they are paying you in the year you worked so that you get taxed on that money in the correct year. 

The Mandatory Deductions

Federal, State, and Local Taxes

Federal taxes are a percentage of your income. It’s determined by the amount you make each year minus deductions you may have and then each bucket of your income is taxed according to the tax brackets. If you want to seriously nerd out about all of this, I love this article that really breaks it down with real-world examples.

State and local taxes greatly depend on where you live.

Note: If you are a freelancer, you may not have taxes taken out of your check, but you will owe them at the end of the year if you’ve made more than $600 with that company. If you do this a lot, it’s really important to budget for the taxes you’ll owe. If freelancing is your full-time gig, you should file quarterly. 

Social Security and Medicare

The Federal Insurance Contributions Act (FICA) requires that you make contributions to Social Security and Medicare with each of your paychecks. In comparison to the taxes that are taken out, these numbers are quite a bit smaller. But it still stings a bit to have it taken out each time. Currently, the Social Security tax rate for employees is 6.2% (for income up to $117,000). The Medicare tax rate is 1.45% for everyone.

Ideally, these are things that one day we will be able to take advantage of when we retire, assuming the plans are still around when that happens. It’s a little sad to think about it that way, but good to remember to not rely completely on these plans and to contribute to your own retirement plans too.

For more info on Social Security and Medicare and how they’ll play into your retirement later in life, I like these articles (Social Security, Medicare).

The Voluntary Contributions

Benefit Contributions

Many employers offer partial coverage of benefits and the employee will also contribute to the plan monetarily. This includes things like your health plan and life insurance policy but also can include things like parking at work and/or company-sponsored gym memberships.

As you decide what benefits you want to take advantage of during open enrollment or when you start a new job, you should also see what gets taken out pre-tax vs. post-tax. This will change the amount of money you get in your paycheck and the amount you get taxed on each year.

Retirement Contributions

If the company that you work for offers a 401k, 457b, or 403b plan and you’ve elected to contribute to it, that will be taken out of your paycheck each time before taxes. If the company that you work for offers a Roth version of any of these plans (i.e. Roth 401k) and you’ve elected to contribute to it, that will be taken out of your paycheck after taxes.

If you are contributing to a Roth IRA, then you will do that yourself after you get your paycheck with post-tax earnings.

You may also see a pension plan deduction on your paycheck. Be sure to chat with your employer when you are hired about how much may be taken out of your check for a mandatory contribution to pension plans so that you know how much your take-home pay will be. Pension plans are great (and rare these days!) so if you have one, it’s a huge benefit. But that means that a big chunk of your income might be taken out to support that and you just want to be prepared and/or use it to negotiate a higher salary to help with your present living costs.

Health and Dependent Care Contributions

A few months ago, I got very excited about pre-tax health and dependent care contributions and wrote a whole post about it. But the basics are that you can add pre-tax money to accounts to help pay for health and dependent care costs and thus pay for those things with earnings that you haven’t been (and won’t be) taxed on. Because those contributions are pre-tax, the money will be taken right out of your paycheck before you get the earnings.

Involuntary Items

In some cases, you may also have involuntary items withheld from your paycheck. This would be things like child support, defaulted student loans, and unpaid court fines.

It’s hard to have your base paycheck number that you have in your head get whittled down with all of these deductions, but it really does help to understand where all the money goes.

It’s also something that changes from year to year and job to job. One of my favorite podcast episodes is about how the 401k retirement plan could change over the years and be completely different by the time you retire. Give it a listen here.

I love reading about all of these things and learning about where my money goes each month. If you have favorite articles or thoughts on paycheck deductions, please tell me about it in the comments!

Let us know what you think!