Got Your First Job? Understand Your Paycheck
What you'll learn
- The difference between gross pay and net pay
- How taxes and other deductions affect your paycheck
- Why understanding your take-home pay can help make budgeting more successful
Let's be honest: The best part of starting a new job is getting that first paycheck!
But you might be surprised to see that your paycheck is smaller than you expected. What gives?
Unfortunately, you rarely get to keep every dollar you earn. Welcome to the wonderful world of taxes.
What you earn = gross pay
Not "gross" as in "ew." "Gross" as in "total."
Gross pay is what you earn before any money has been taken out for taxes or other things (more on those later).
It's calculated by multiplying your hourly pay rate by the number of hours you worked during the pay period. This might be what you expected to see on your first paycheck.
| Hourly pay rate | Hours worked | Gross pay | ||
|---|---|---|---|---|
| $15 | x | 20 | = | $300 |
What you keep = net pay
Depending on how much money you earn, you might owe taxes to the federal government and to your state. Once you're a bit older, you might also pay for medical insurance or contribute to a retirement savings account. If you do, your employer will take all those taxes and any expenses (called deductions) out of your paycheck, too.
What's left over is your net pay, and it's the amount you actually get to keep.
What's left over is your net pay, and it's the amount you actually get to keep. This is the number you should use in your budget to figure out how much you can afford to spend on needs, wants, and savings.
What's up with taxes?
So, which taxes will you have to pay? Let's take a look.
Income taxes
The state and federal governments take a percentage of your income to help pay for things you probably use all the time, like your school, the public library, and even the airport.
But not everyone owes the same percentage of taxes. The more money you earn, the higher your rate.
And some people don't owe taxes at all. You might not, either, if you make less than what's known as the standard deduction. This is the amount every person filing taxes gets to subtract from their gross income before calculating how much income tax they owe. And it usually changes every year.
| How much income they earned this year | Example standard deduction | Taxes owed? | |
|---|---|---|---|
| Lucas | $7,500 | $14,600 | No |
| Zoe | $15,000 | $14,600 | Yes |
If you know you'll earn less than the standard deduction, you can choose "tax-exempt" on your federal and state tax forms. That means your employer won't take out any taxes from your paycheck.
Be sure to get help from your parents or a trusted adult when filling out your tax forms. Taxes can be complicated—even for tax pros.
Payroll taxes
Ever heard of Social Security? It's like one big retirement savings account that most workers—even you—are required to contribute to.
As part of the Federal Insurance Contributions Act (FICA), Social Security is considered a tax, but it's actually a benefit to you—and everyone else who contributes to it. Once you retire, you'll receive monthly payments based on how much money you paid into Social Security over the years.
| Your gross pay | Social Security tax | Amount deducted from your paycheck |
|---|---|---|
| $300 | 6.2% | $18.60 |
Medicare is another FICA retirement benefit you're required to contribute to each paycheck. It's a health insurance plan for retirees and you'll be eligible for it once you turn 65.
| Your gross pay | Medicare tax | Amount deducted from your paycheck |
|---|---|---|
| $300 | 1.45% | $4.35 |
Other taxes
Your state may collect other taxes, like those to cover unemployment or disability benefits.
What are deductions?
These are optional payments to take advantage of benefits offered by your employer.
Retirement savings
Many employers offer what's called a 401(k) plan. If yours does and it allows you to contribute (some have minimum age requirements), you should really consider it. It's never too early to start saving for retirement.
But, why? Retirement is so far away!
Well, even contributing just a few dollars per paycheck can really add up over time. Especially if your employer offers to match part of your contribution. Most employers offer a match of 3% to 5% of your pay. That's like free money. But you only get it if you contribute at least that much, too.
| Your gross pay | Your contribution | Your employer's contribution | Your total 401(k) savings per paycheck |
|---|---|---|---|
| $300 | $15 (5%) | $9 (3%) | $24 |
Medical insurance
You're probably still covered by your parents' medical insurance. But once you start working full time, you might be able to get your own insurance through your employer. Some employers even pay some of or all of the costs.
Knowledge is power
Now that you understand taxes and deductions, hopefully you won't be surprised when you get your next paycheck.
More important, knowing how much money you get to keep from each paycheck makes it easier to set a budget and understand what you can really afford. This is called "living within your means" and it's key to building healthy spending habits and achieving your financial goals.
Quiz
1. Does everyone owe taxes?
A. Yes
B. No
C. It depends
Answer: C | If you earn money, you generally owe taxes. But if you know you'll make less money than the standard deduction, you can claim tax-exempt status. That tells your employer not to deduct any taxes from your pay. And paying less tax means you get a fatter paycheck!
2. True or false? Contributing to Social Security and Medicare is optional.
Answer: False | If you have a job, you generally have to pay Social Security and Medicare taxes. But don't worry. That's not lost money. You'll get it back in the form of retirement payments and medical insurance when you retire.
3. Why is it important to understand your net pay?
A. It helps you set a real-life budget
B. It helps avoid surprises when you get your first paycheck
C. It helps you live within your means
D. All of the above
Answer: D | Remember, how much you earn and how much you keep aren't usually the same. Your take-home pay is really the only number that matters. When you understand how much money you actually have you can figure out what you can afford to spend on your needs, wants, and goals.
Your next steps
- Look at the pay breakdown on your most recent paycheck and circle all the taxes and deductions. Discuss anything you don't understand with your parents.
- Talk to your parents about the taxes and deductions they pay. Are you surprised by how much (or little) they get to keep?
- Learn about creating smart spending habits and using credit cards wisely.