A paycheck is a powerful thing. You use it to pay for what you need today, and to save for what you’ll need tomorrow—a down payment for a home, a college education, a comfortable retirement. In other words, your paycheck is the foundation for your entire financial life. Yet many people are mystified by it. There are taxes, benefits, and even deductions to consider. Getting your financial house in order starts with understanding exactly what’s going on with your paycheck.
Your take-home pay is not the same as your salary
Salary is what you earn before money is taken out for things like taxes and benefits.
Your pay-check deductions are for things like federal and state taxes, Social Security, Medicare, health insurance, and retirement savings.
How are federal taxes computed?
The tax formula is complicated, but the more you earn the higher percentage you pay in taxes.
This is what’s known as a graduated tax system.
How are state taxes computed?
Each state has its own income tax system. Some use a graduated system. Some, like Massachusetts, have a flat rate, meaning everyone pays the same percentage regardless of their income. Some states, like New Hampshire, have no income tax at all.
Social Security and Medicare taxes
Social Security is a tax on your income. Your employer pays half of that tax and the rest is deducted from your paycheck. If you work for yourself, you’re required to pay the entire percent tax.
Medicare is a federal program that provides hospital insurance. To pay for it, the government collects a tax on your income. Your employer pays half of the tax and the rest is deducted from your check. If you work for yourself, you’re required to pay the entire tax on your own.
Quarterly estimated tax payments
When you work for someone else, your taxes are automat- ically taken out of your check each pay period. But when you work for yourself, this doesn’t happen.
If you’re self-employed, the government requires you to file taxes four times a year—every three months.
You pay based upon how much you estimate that you’ll earn in the upcoming three-month period. Underestimating can result in penalties and interest charges.
Other paycheck deductions
Your company may offer other benefits, such as health and dental insurance, retirement-savings programs, or transportation subsidies.
Each company will have its own benefits, and associated costs, and it will be up to you to decide which you’d like to take advantage of.
The money you contribute for some benefits—your retirement savings, for example—may be tax deductible, meaning you can subtract it from the amount you have to pay taxes on.