How to Understand Your Paycheck

You probably remember the thrill of earning your very first paycheck. All that money you worked so hard for, yours to keep and spend on whatever you like. Except … wait a minute. There must be a mistake. Where's the rest of it?

That was probably also the first time you experienced the painful reality of taxes and just how much of your pay they eat up.

If you're new to the workforce, or if you want to help your teen or young adult understand their first paycheck, here's what you need to know.

Understanding your paycheck

Personal information

At the top of your pay stub, you'll find a few relevant items of information, such as the last four digits of your Social Security number, your taxable marital status (single, married filing jointly, etc.), and federal and state exemptions. The latter portion refers to the number of exemptions you claimed for yourself and any spouse or dependents on your W-4 form.1 Exemptions allow you to adjust how much money is taken out of your pay for taxes.

Hours worked

If you're an hourly employee, your paycheck will show the total number of hours you worked for the pay period. If you're salaried, this section will display the total number of hours in a standard pay period at your job.

Earnings

Also known as your gross pay, this is the total amount of money you earned during the pay period based on the number of hours worked. This represents your full hourly pay or salary before any deductions are taken out. If applicable, your earnings will be broken out by regular hours, overtime, and holiday/vacation pay. Usually (and unfortunately) this number is quite a bit bigger than your actual take-home or net pay.

Withholdings

Next is the not-so-fun part of your paycheck. The withholdings section covers all of the taxes and other money withheld from your gross pay:

• Federal income tax: The federal government collects taxes from every paycheck you earn. How much you pay in income taxes will depend on how much money you earn and how many allowances you claimed on your W-4 . (An allowance reduces how much income tax an employer deducts from your paycheck.) The United States follows a progressive tax system, which means the more you earn, the more you're taxed. For example, take a look at the tax brackets for 2018: If you earn $40,000 in taxable income for the year, then the first $9,525 will be taxed at 10%, the next $29,174 will be taxed at 12%, and the remaining $1,300 will be taxed at 22%.2
• State income tax: Depending on where you live, you might have to pay state income taxes in addition to federal income taxes. State income tax rates vary by state,3 and some states — such as Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming — are income tax-free.4
• Social Security tax: Every worker is required to contribute a small portion of income (6.2%, up to $128,400) to the Social Security fund, which provides financial assistance to retirees, disabled workers, and families in which a parent or spouse died.
• Medicare tax: The government also requires workers to pay into the Medicare system, which is a federal health insurance program for Americans age 65 and older. Just 1.45% of your paycheck goes to this tax.
• Insurance: If you're enrolled in medical, dental, or vision insurance through your employer, any premium you're responsible for paying is taken out of your paycheck as well.
• Retirement savings: If you participate in an employer-sponsored retirement savings plan such as a 401(k), contributions will be deducted from your gross pay. The benefit to participating in a retirement plan through your job is that your contributions are made pre-tax, which means that you don't pay federal or state income tax on the money you contribute.
• HSA/FSA: If you contribute to a health savings account or flexible savings account through work, these contributions are also deducted, pre-tax, from your paycheck.

Net pay

Once all your taxes and other withholdings are deducted from your gross pay, you're left with your net pay. This is the actual dollar amount that you get to pocket. Woo-hoo! For example, if your gross pay was $500 and you had $200 withheld for taxes and other deductions, your net pay would be $300.