Understanding Paycheck Deductions

What are Paycheck Deductions?

Think of your paycheck as an extra-large pizza. The entire pie is your gross pay, or the total amount you earn before anything is taken out. This is easy to calculate—simply multiply your hourly wage by the number of hours worked.

But hold on! Before you can eat—or in this case, spend—the entire pizza, a few slices are taken out of it. Everyone that works has slices removed, so it’s not just you. Some of the slices removed are for mandatory contributions to federal services like Social Security and Medicare. Everyone pays federal income taxes, too, that goes toward services like the military, federal police, roads and bridges, school, and more.

Other slices out of your pizza may be ones you choose to remove, like voluntary contributions to a retirement savings plan or to pay for health care through your employer. The slices left after everything is removed is what’s left for you. This is your net pay, and it’s the amount you actually get to keep and spend.

Do I Pay Taxes on Tips?

Anyone with a job is required to pay taxes on most types of income—this includes wages, salaries, commission, tips, investment earnings, self-employment income, and more. Yes, even tip money is taxable. If you earn tips, the IRS expects you to keep a record of all the forms of tips received and report anything over $20 to your employer by the 10th of each month. Your employer includes this information in your W2 form, and you’ll use that to file your annual taxes.

What is a Progressive Tax System?

The United States has a progressive tax system. This is where the tax rate increases as income increases. In pizza terms, if you have a smaller pizza, the slices taken out are smaller; a medium pizza has medium slices taken out; and an extra-large pizza has the biggest slices removed.

There are ways to impact the size of the slices taken out of your pizza, no matter the size. In tax terms, these are referred to as deductions and credits. They are like coupons that reduce the size of your pizza as viewed by the federal government, and in turn, impact the size and number of slices you need to give away. Some examples of things that could earn you common deductions and credits are the number of dependent children you have at home, any charitable donations you make, and more.

Remember, everyone has at least some part of their paycheck deducted. The consequences of not paying income tax are serious—there are late penalties, interest charges, damage to your credit score, and even legal consequences like liens against your property and jail time. Yes, it’s that serious!

What Does Social Security Pay For?

When you contribute a slice of your paycheck pizza to programs like Social Security and Medicare, those contributions benefit your future self. When you retire, you can receive money from Social Security to help pay for the cost of living—food, housing, healthcare—when you’re no longer working. Think of it as a safety net. Ideally, you’ll have other retirement funds to draw on, too. To qualify for Social Security, you need to earn a specific number of “credits” through your working years. Currently, you need 40 Social Security credits for retirement benefits, about 10 years of working full-time. But you’ll receive the maximum benefit if you work at least 35 years.

Social Security also helps people if they become disabled and cannot work. Or, if someone in the family who does work dies, Social Security can help the family left behind. Deductions also help fund Medicare, which pays for healthcare for older people.

When you work, your employer contributes money to your Social Security account, too. In fact, they pay half of your required 12.4% contribution—you pay 6.2% of your earnings automatically from your paycheck, and they contribute 6.2% too. If you are self-employed, you are required to pay the full 12.4% on your own.

You don’t automatically get that 12.4% back when you retire. Social Security is not a pay-in, get-out system. The money you pay now goes into a trust fund that is used to pay qualifying people who are currently retired. The amount of Social Security you’ll receive when you retire is determined by several factors:

• Your highest 35 years of earnings at work>/li>
• Your age when claiming Social Security
• How long you live
• Future changes to the Social Security system

Other Government Programs

Your paycheck deductions also fund other federal programs that support those who need income support or other assistance paying for food or healthcare for their families.

These programs include:

• Supplemental Nutrition Assistance Program (SNAP). This program helps low-income individuals and families purchase groceries with an Electronic Benefits Transfer (EBT) card. The program used to be known as food stamps. Qualifications vary by state, as do the work requirements to qualify.
• Women, Infants, and Children (WIC). This provides nutrition assistance and education to low-income pregnant women, new mothers, and children up to age 5.
• Medicaid. A program that provides affordable healthcare to low-income people or vulnerable groups like young children, people with disabilities, and the elderly.

Contributing to benefits and services through deductions is a normal part of having a job and an important part of functioning society.