The gap between salary and reality
A $60,000 salary sounds like $5,000 per month. It isn’t. After federal taxes, state taxes, Social Security, Medicare, and benefit deductions, the actual deposit might be $3,800. That’s a 24% reduction before you’ve spent a dollar.
Understanding this gap matters because budgeting from gross income guarantees failure. You can’t spend money that never reaches your account. Net pay—the actual deposit—is the only number that matters for daily financial planning.
Gross pay vs. net pay
Gross pay is your full earnings before any deductions. For salaried employees, it’s annual salary divided by pay periods. For hourly workers, it’s hours worked times hourly rate, plus any overtime.
Net pay (take-home pay) is what actually deposits into your bank account. The difference between gross and net represents everything withheld: taxes, benefits, retirement contributions, and other deductions.
The ratio between net and gross varies significantly based on income level, state of residence, benefits elections, and retirement contributions. Someone might take home 80% of gross; someone else might take home 65%. Knowing your personal ratio helps with financial planning.
Mandatory deductions: Taxes
Several tax withholdings appear on every paycheck:
Federal income tax is withheld based on your W-4 form elections. The amount depends on your filing status, claimed dependents, and any additional withholding you’ve requested. This isn’t the actual tax you owe—it’s an estimate. The true amount is calculated when you file your return, resulting in either a refund or additional payment. For details on how tax brackets work, rates are progressive—not all income is taxed at your highest bracket.
Social Security tax (OASDI) is 6.2% of gross wages up to an annual cap ($168,600 in 2024). This funds retirement and disability benefits through the Social Security Administration. Your employer pays an additional 6.2%, so the total contribution is 12.4%.
Medicare tax is 1.45% of all gross wages with no cap. An additional 0.9% applies to wages above $200,000 for single filers. Combined with the employer portion, Medicare receives 2.9% of your wages.
State income tax varies dramatically. Nine states have no income tax at all. Others range from flat rates around 3% to progressive systems exceeding 10% at high incomes. Your state’s department of revenue website provides specific rates.
Local taxes apply in some cities and counties. New York City, for instance, adds its own income tax on top of state tax.
Together, FICA taxes (Social Security + Medicare) total 7.65% of your gross pay—a significant and unavoidable deduction that applies regardless of income level.
Pre-tax deductions
Some deductions reduce your taxable income, meaning you pay less in taxes. These “pre-tax” deductions are financially advantageous:
401(k) or 403(b) contributions come out before federal and state income tax (though not before FICA). Contributing $500/month doesn’t reduce your paycheck by $500—it reduces it by less because the contribution also lowers your tax bill. This is why retirement account contributions are so valuable.
Health insurance premiums are typically pre-tax when offered through an employer plan. A $200 monthly premium might only reduce take-home pay by $150-170 after accounting for the tax savings.
Health Savings Account (HSA) contributions are pre-tax and offer triple tax advantages—a rare benefit in the tax code.
Flexible Spending Account (FSA) contributions for healthcare or dependent care are also pre-tax, reducing taxable income.
Commuter benefits for transit or parking may be pre-tax up to certain limits.
Pre-tax deductions appear to “cost less” than their face value because they simultaneously reduce your tax burden.
Post-tax deductions
Some deductions come from pay after taxes have been calculated. These don’t reduce your tax bill:
Roth 401(k) contributions are post-tax—you pay taxes now but withdrawals in retirement are tax-free.
Life insurance premiums above certain thresholds are post-tax.
Disability insurance (if employee-paid) is typically post-tax.
Wage garnishments for debts, child support, or tax levies are post-tax deductions that creditors can require employers to withhold.
Union dues are typically post-tax.
Post-tax deductions cost their full face value in reduced take-home pay.
Reading your pay stub
A typical pay stub contains several sections:
Earnings shows gross pay for the period plus any overtime, bonuses, or other compensation. Year-to-date totals help track annual earnings.
Taxes lists federal, state, and local tax withholdings plus Social Security and Medicare. Each shows current period and year-to-date amounts.
Deductions itemizes benefits: health insurance, dental, vision, retirement contributions, HSA/FSA, life insurance, and any other withholdings.
Net pay is the final result—what deposits into your account.
Employer contributions (if shown) displays what your employer pays for benefits on your behalf. This isn’t part of your compensation directly but represents significant value.
Reviewing pay stubs periodically catches errors. Incorrect tax withholding, missing deductions, or miscalculated overtime can go unnoticed for months if you never look.
Why withholding isn’t exact
Tax withholding is an estimate, not a precise calculation. Several factors make it imperfect:
The IRS withholding tables assume your current paycheck represents typical earnings all year. Bonuses, overtime, or irregular income can cause over- or under-withholding.
Life changes (marriage, children, home purchase) affect taxes but don’t automatically update withholding. The IRS Tax Withholding Estimator helps calculate whether your withholding matches your expected liability.
Some people prefer over-withholding (getting a refund) as forced savings. Others prefer accurate withholding to keep more money throughout the year. Neither is wrong—it’s a preference about when you want access to your money.
Adjusting your withholding
The W-4 form controls federal withholding. You can submit a new W-4 to your employer anytime circumstances change.
If you consistently get large refunds (over $1,000), you’re over-withholding. Adjusting allows more take-home pay throughout the year rather than an interest-free loan to the government.
If you consistently owe at tax time, you’re under-withholding. Adjusting prevents a large bill (and possible penalties) when you file.
The W-4 allows claiming dependents, indicating other income sources, and requesting additional withholding. Getting it right means your paycheck withholding closely matches your actual tax liability.
The value of benefits
Employer-sponsored benefits have monetary value beyond salary. Health insurance that costs an employer $600/month would cost you $800+ on the individual market. A 401(k) match is free money. These benefits are part of total compensation even though they don’t appear in your bank account.
When comparing job offers, looking only at salary misses significant value. A $70,000 job with excellent benefits might provide more total value than a $75,000 job with minimal benefits.
Understanding your paycheck means understanding this total picture: gross pay, deductions, benefits, and the net result that funds your actual life.
Common paycheck questions
Why did my withholding change mid-year? Tax law changes, W-4 updates, or crossing income thresholds can alter withholding. Your employer’s payroll system recalculates based on current information.
Should I adjust withholding to get a bigger refund? A large refund means you over-withheld—essentially giving the government an interest-free loan. Most financial advice suggests adjusting for smaller refunds and more take-home pay throughout the year. But some people prefer forced savings via over-withholding.
My first paycheck seems small—is this normal? If you started mid-pay-period, your first check reflects partial work. Additionally, benefits deductions may be “front-loaded” or caught up in early paychecks. By month two or three, paychecks typically stabilize.
Why do I owe taxes despite withholding? Common causes include: multiple jobs without adjusting W-4s, significant non-wage income (investments, side gigs), life changes not reflected in withholding, or under-withholding on bonuses.
Understanding your paycheck transforms it from a mysterious deposit into a clear picture of your earnings, deductions, and where your compensation actually goes.