College graduation is a major milestone in life. All the book learning is finished and it’s time to get some practical experience. The best part? Along with this first “real” job, comes the first “real” paycheck. But with this new income, there is also responsibility - to manage it in a way that will create the best financial situation for the future. Understanding all the intricacies of a paycheck is crucial in planning healthy personal finance, so it’s important to know common terms, how the W-4 fits into all this, and what payroll taxes are deducted. For most people, there are federal, state and local taxes taken from each paycheck.
First, an understanding of the basic terms found on a paystub is helpful. Below are some of the most common terms, and their definition:
- Rate: The hourly rate you are paid. Hours: The number of hours you are being paid for in this pay period.
- This Period: How much you were paid in this current pay period.
- Year to Date: How much you have earned this year.
- Gross Pay: The total amount you earned before any deductions.
- Net Pay: The total amount you earned after deductions. This is the amount you have to live on each pay period.
Next, accurately completing a federal W-4 (Employee’s Withholding Allowance Certificate) is critical for properly managing your finances, so it’s important that you understand it. Using a paycheck calculator from PaycheckCity can help with determining the appropriate amount to claim, and is useful in checking a few different scenarios to determine which is the right withholding. A W-4 can be changed at any time for an increase in allowances, but if the amount of allowances decrease you must update it within 10 days. Each withholding allowance reduces the amount of taxable wages and results in less federal income tax withheld from a paycheck. It is based on an employee’s marital status and withholding allowances claimed.
Allowances are based on three things:
- How many withholding allowances are claimed. Some permissible withholding allowances include:
One for the employee, unless he or she is claimed as a dependent by someone else.
One for the employee’s spouse unless the spouse is working and claims the allowance on their W-4.
One for each dependent
- Whether the employee wants any additional amount withheld
- Whether the employee claims to be exempt from withholding
Finally, it is important to understand what taxes will be deducted from a typical paycheck. These payroll taxes include:
- Federal income tax withholding, based on the number of deductions you claimed on your W-4, and the withholding tables in 'Publication 15, Employer's Tax Guide' by Internal Revenue Service.
- FICA - this stands for Federal Insurance Contribution Act. It includes both Social Security tax and Medicare tax.
Social Security - The employee pays 6.2 percent (this was reduced to 4.2% for this year only) of the salary or wage, up to $117,000. The employer also pays 6.2 percent in Social Security taxes. If you are self-employed, you pay the combined amount of 12.4 percent in Social Security taxes on your net earnings.