Most people have an employer as their primary and sole income producer so let’s talk about pay stubs. These usually get delivered every few weeks yet no one has ever learned what all the numbers mean. Most just say “give me the money” but it’s relevant to understand the levers that impact income.
All pay stubs will look different based on the payroll provider your company or organization use but the basics will always be reflected.
Somewhere on the pay stub (usually at the top), you’ll see personal identification information. Some examples that could be included are:
· Full name,
· Employee ID
· Start date
Other information that’s typically listed at the top would be:
· Pay Period Start and End Date
· Pay Date which is the actual day the check gets paid to you
One thing that is important to note is the date you actually get paid for services rendered because this is part of what determines your income in that taxable year. So, for example if someone was paid on January 3rd of 2020 (even if they were paid for services rendered in December), it would be taxable income in 2020.
The next section is the current gross income received both in this specific pay period as well as year-to-date, usually. “Gross” simply means before any taxes or deductions are taken out.
Gross salary usually looks pretty attractive and my clients often say “wait…I make that much!” and the answer is “not quite”. Before anyone takes home any pay, the government needs to collect and depending on your employer and situation, you may also have some expenses pulled directly from your pay stub.
There will be a section called “Deductions” or “Pre-tax Deductions” or something of that nature. These deductions are taken out of your pay stub BEFORE and applicable federal, state or city taxation can be applied. So, what does that mean for you? Well it means that every dollar spent on these pre-tax deductions brings down your income by that exact dollar amount. If you make $100,000 year and have $10,000 in pre-tax deductions, for the purposes of the IRS and state taxation agencies, you actually made $90,000 in the eyes of the government. Put simply, you are not taxed on these dollars for income purposes in the current year. Pretty cool, huh?
What types of deductions are there?
Deductions can be self-selected such as benefits you enroll in or employer mandated such as a pension in which you’re required to contribute. Some of the most common pre-tax deduction examples include:
· 401k/457/403b employer retirement elective contributions
· Pension required contributions or elective contributions
· Healthcare plan
· Dental plan
· Vision plan
*Important note is that while pre-tax deductions are federal and sometimes state tax deductible, FICA taxes may still apply to your gross income.
An after-tax deduction is also a type of deduction; however, they are not pre-tax so they don’t bring down your taxable income in the current year. Again, these depend on your employer but some common ones include:
· Roth or After-tax contributions to 401k/457/403b
· Loans to 401k/457/403b
· Elective insurance group policies (life insurance, disability, etc.)
· Charitable contributions
The pricing of these benefits will be based on your employer’s group plan and the pricing of that plan, if your employer even offers those benefits.
This section of a pay stub includes federal tax, Social Security* and Medicare since U.S. citizens are typically subject to these taxes.
What will differ is state taxes, local taxes, and other types of taxes in which someone is subject to based on their locale.
Also, it’s important to note that these amounts are withholdings, not the tax amount actually owed. This is why everyone has to go through the exhilarating process of filing taxes each year. This means that someone should think about how much they should withhold and make that decision when starting with a new employer. When starting a job, the W-4 specifically tells the employer and payroll provider what to withhold.
At the end of the day, someone shouldn’t withhold too little due to the burden of having to pay a large chunk to the IRS (and possible penalties) in April but also shouldn’t over-withhold because that money that the IRS is withholding isn’t sitting in an interest accruing account and isn’t “working” for that person.
Pay stubs are often most Americans receive but never fully understand and the importance of being able to read this document is important for financial empowerment.
*Important note some jobs are exempt from social security