Understanding Your Paycheck

Quite often we find ourselves focused on what to do with the money we have, and we often don’t take the time to look and see what we have taken out before we even see the money.  Eventually when tax time rolls around, we see it as a time of feast or famine where we might get a little bit of extra money to splurge with. While that definitely isn’t the responsible behavior we like to encourage, there is a time and a place for that discussion. More important to the discussion is understanding how your paycheck works, and how to make sure you set up your deductions so that you only pay the correct amount of taxes, no more and no less.

First, take your paycheck and subtract your pretax deductions (Health Insurance, Retirement Plan, FSA, etc.) then, follow these steps:

1)      Multiply your income by the Social Security tax rate. As of 2013, the rate is 6.2 percent. For example, if you earned $3,900 per month, you would pay $241.80 in Social Security taxes.

2)      Multiply your income by the Medicare tax rate, which is 1.45 percent as of 2012. Continuing the example, if you had a monthly paycheck of $3,900, $56.55 would be withheld from your paycheck for Medicare taxes.

3)      Multiply the number of personal allowances you claimed on your W-4 form. Each allowance decreases the amount of your paycheck that is subject to income tax withholding. As of 2012, the annual value of each personal allowance is $3,800. For example, if you claimed three allowances, the total value would be $11,400.

4)      Divide the value of your personal allowances by the number of pay periods per year. In this example, since you are paid monthly, there would be 12 pay periods per year; you would divide $11,400 by 12 to get $950.

5)      Subtract the value of your allowances from step 4 from your paycheck to find the amount of income subject to tax withholding. Continuing the example, you would subtract $950 from $3,900 to get $2,950.

6)      Use the federal tax withholding tables to find out how much money is withheld from your paycheck for federal income taxes based on your filing status. For example, if you were single and had a monthly income subject to withholding of $2,950, you would have $379.40 withheld for federal income taxes.

7)      Repeat with your state and local income tax withholding tables if you live in states or localities that charge an income tax. These tables are available from your state or local department of revenue.

If you want to speed up the process, there are also paycheck calculators online. Paycheckcity provides a calculator that is generally accurate up to about $10 per paycheck, which is accurate enough for estimation, but you should always be aware that they are normally subject to your company’s HR department’s own calculations and can vary slightly based on the software they use.

Until Next time, go snack on some debt!