Understanding Your Payroll Deductions (US)

By Cindy Diccianni, RN, CSA, CWI, CLTC

Congratulations on starting your new job! You're making a salary and moving forward financially. But when you get your first check, you find a list of items and several deductions. What does it all mean?

Income

Gross salary is the amount of money you were hired for, whether it is an hourly rate or salaried rate. If you are an hourly employee, to determine your gross salary, simply take your hourly amount and multiply it by the number of regular hours worked. For example, if your hourly rate is $25.00 and you work a 40-hour week, multiply $25 x 40. Your gross weekly earnings are $1,000; you would then multiply this by weeks worked to obtain your annual gross pay.

The gross earnings amount can be substantially higher than your net earnings, which is your gross salary minus all of the taxes and other deductions. In other words, your net earnings are the amount of money you actually take home.

The amount of overtime hours and the overtime rate may be the next entry on the income side of your paycheck. Overtime is generally time-and-a-half but can also be double-time or triple-time. Other sources of income can include bonuses, incentive bonuses, on-call base salary, etc.

A. Standard Deductions

There are several standard or base deductions that everyone who claims an income must pay. These are as follows:

1. Federal Income Tax – This is the tax that is charged to you based on your gross income minus any "pre-tax deductions," such as retirement plan contributions, e.g. 401(k), 403(b), or certain healthcare and childcare contributions, e.g. those that are part of a Flexible Spending Account (see below). Pre-tax deductions are those which lower your taxable income. So, for example, if an individual earns $50,000 in a year, but contributes $10,000 to a 401(k), then the individual is only taxed based on an income of $40,000.

2. Federal Insurance Contributions Act (FICA) – FICA contributions fund Social Security (the national program to provide unemployment compensation, old age pension, welfare, etc.) and Medicare (the national health insurance program for individuals aged 65 years and older). The Social Security portion is 6.20% and the Medicare portion is 1.45%, totaling a combined tax rate of 7.65%. Currently, there is a Social Security cap on earnings of $87,900, which means that the amount of tax goes down based on gross salary.

3. State Taxes – These vary according to the state in which you work and live; some states do not have personal income tax.

4. State Unemployment and Disability – Certain states require employees to contribute to this program. This is a complex system that varies widely from state to state.

5. City, Local, and/or County Taxes – These vary depending on the area that you live and work. There can be a credit issued if you work in the city and live in the suburbs.

B. Retirement Plan Deductions

You are not required to participate in retirement plans, but often they are offered as a benefit of employment. It's always a good idea to take full advantage of these programs – especially if they are calculated at a pre-tax rate, like these plans below:

1. 401(k) and 403(b-7) – 401(k) plans are for for-profit institutions and 403(b-7) plans are for non-profit institutions. In these plans, a company match is paid to you, usually once a year, as an employer contribution. The contribution ceiling for gaining pre-tax benefit is set annually, and for 2004 is $13,000. If one does not contribute the maximum amount, the remainder cannot be carried over into subsequent years. Individuals over age 50 can contribute $500 per year above the contribution ceiling.

2. 403(b) – This is a pre-tax retirement contribution that you make to the account, which lowers your federal taxable amount. There is no company match made.

3. Simple IRA Plans – These plans are generally for smaller companies. There is a smaller match of 1-3% made by the employer.

You can begin drawing from a retirement plan – for retirement income or other spending – at age 59.5 years. The withdrawn money is subject to federal and state taxes, which can be a substantial, depending on an individual's tax base. However, you withdraw money from the plan before age 59.5, there is a 10% IRS penalty in addition to federal and state taxes.

Miscellaneous Deductions

Many employers offer a variety of benefits that are available through payroll deductions. Some of these include:

Group Life Insurance – These policies generally offer "one-times your pay" term plans, which mean that if your income is $50,000, the insurance payout would be $50,000. These plans have no underwriting guidelines. They are offered to the employee free or as an optional benefit (i.e., if you are given a list of benefits to choose from). If you have difficulty obtaining your own life insurance you should take full advantage of this benefit – especially if you own a home or have a family. Some employers allow you to increase the amount of the coverage to two-times or three-times your pay. While the employer covers this premium increase, any payout beyond one-times your pay is taxable. (Note: once you leave this employer the coverage stops.)

Disability Plans – Short-term and long-term disability plans are often part of the benefit plans for larger employers. Disability is the most common event in an employee's life and one of the most underinsured events. The best advice that I give to my clients is to have some sort of short-term and long-term disability coverage. Short-term disability generally covers the first 90 days of a disability and long-term disability covers anywhere from two years to age 65, depending on the plan. The longer the covered period, the higher the costs to you. Group plans have substantial discounts, which help in the total out-of-pocket costs to you. Disability plans may be paid for by the employer, or as a shared employee-employer expense. (Note: once you leave the employer the coverage either stops or can be carried on by you – thus paid for by you – at a non-group rate.)

Long-term care – Many employers sponsor group long-term care plans for employees. These plans provide a good base plan of coverage. You can purchase a private plan for additional coverage if needed. It is advisable to buy these plans, if possible, in your early 50s. (Note: these plans are fully portable, meaning they go with you if you change your employment situation or retire.)

Savings Bonds – Monthly or quarterly savings bond purchases are available through many of the larger employers. This is a safe, convenient benefit for a fixed portion of your overall portfolio but the current rate of return on your money is low. (Note: once you leave the employer you cannot participate in this plan; however, the bonds in your possession are yours to keep.)

College Planning – One of the most recent trends is to offer a 529 Plan (a company-sponsored tuition savings plan). This allows employees to save money toward either their children's education or their own education.

Flexible Spending Accounts – These are pre-tax plans. The accounts are used to help employees save money for childcare costs and for medical-related deductibles and other expenses that are not covered by their employer's plans. This is a great benefit (if you closely calculate your yearly costs) because it can lower your pre-tax income. Caution must be used in calculating these deductibles and expenses, because if you do not use these assets in the given year you lose them. Nonetheless, for those who have fairly predictable bills, such as for prescriptions or daycare, it is worth the risk.

Union Dues – The dues paid to a union are taken out of your paycheck with each pay period. If you are working in a facility with a "closed shop," meaning you have to be a member of the union, then these dues mandatory. Union dues must be itemized on your tax form to be tax deductible.

Many of these benefits will differ each year and with each new facility or union contract. The best benefits for you are the ones that lower your taxable rate, allow you to save for retirement, and minimize your personal costs each month. If you have any questions, your benefits coordinator, personnel director, human resources officer, or union leader should be able to help.

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