Demystifying your paycheck

Admit it: you were a little disappointed when you got your first paycheck. Sure, it was great to be making money, but the direct deposit that hit your bank account was a lot smaller than you expected. Here's why.

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Day 1: Get to know your paycheck. This post is part of FORBES' 30 Days of Money.* Follow along on Twitter with #30DaysOfMoney. Also check out FORBES Millennial Money.

Admit it: you were a little disappointed when you got your first paycheck. Sure, it was great to be making money, but the direct deposit that hit your bank account was a lot smaller than you expected. If you are like me, next you scratched your head, vaguely remembered that taxes are a thing and decided to eventually look at your pay stub closely.

Make Eventually Now

Your salary is the starting point of your entire financial life. Earnings dictate how much you will owe in taxes, how much you can save and how much you can spend. In some cases income also determines how much you'll pay toward student debt. The impact of pay is especially powerful for young people who haven't had time to build up meaningful savings. This is why on this first day of our 30 day money challenge we are encouraging you to give your paycheck a once over.

The exercise won't require much more time than it takes to read this article. (In fact, I recommend pulling up a recent pay stub or two and following along as you read.) But the knowledge payoff could be huge. "It is hugely liberating to understand where the money is going," says Isaac Oates, founder of Justworks, which helps small business manage payroll among other services. "For so many people, certainly this was me, you get this pay stub. It looks like this incomprehensible thing with a bunch of letters and acronyms on it. All you know at the end is the money you got is a lot less than the money you thought you'd get. By knowing what you are paying for [...] you can start to make smart decisions."

The Basics

Gross Pay: If you receive an annual salary, and are not eligible for overtime pay, this line shows roughly the amount you shook on when you accepted your job or last raise—divided by the number of paychecks you receive each year. So if you make $52,000 a year and are paid weekly your gross pay will be $1,000.

If you are paid an hourly wage your paycheck will typically show your rate of pay for both regular and overtime work and then multiply both by the respective number of hours worked. The two are added together to get your gross pay.

In both cases gross pay may also include taxable benefits your employer pays, though these are generally added as a separate line item. For example, if your employer covers your gym membership the Internal Revenue Service will view that amount as taxable income. If these "fringe benefits" don't appear on your paycheck they will definitely be on your W-2 come tax time.

Net Pay: Net pay is the punchline of your paycheck. It is what you actually take home after taxes and deductions.

Taxes

Federal Income Tax: If you are an employee, taxes are withheld from each paycheck to cover your tax liability. With federal rates ranging from 10% to 39.6% this tax on earned wages accounts for much of the difference between your gross and net pay. Before cursing your employer for withholding so much money, or more appropriately the IRS for requiring them to, remember that this process saves you from having a massive bill due April 15. That said, if too much is withheld the government gets to hold onto your money until you file for a refund.

Social Security and Medicare Taxes: Sometimes referred to as payroll taxes or FICA taxes, for the Federal Insurance Contributions Act that established them, these taxes fund government income and health insurance for older Americans and everyone pays them. The idea is that you'll pay now and benefit later, though how much today's young people will ultimately benefit is an ongoing debate.

Currently you pay 6.2% in Social Security taxes on wages up to $118,500 and 1.45% for Medicare, your employer pays matching percentages on your behalf. Wages over $200,000 are subject to an additional 0.9% Medicare tax, which employers do not match.

State and Local Income Taxes: Most states—41 of them plus the District of Columbia—collect an additional tax on earned wages. Rate ranges vary widely; Pennsylvania, for example, collects 3.07% regardless of income level. California charges 1% on the lowest earnings and 13.3% on the highest.

Deductions

Beyond taxes the difference between your gross and net pay is made up of expenses deducted from your wages before they hit your bank account, typically voluntary benefits provided by your employer. (One key exception is if your wages are garnished over legal issues or unpaid debts.) You pay for some benefits before taxes, i.e. pre-tax; these reduce your tax bill by making your taxable income lower. Others are post-tax, provided through employers either as a convenience or because they are cheaper at scale.

With a few exceptions—notably the Affordable Care Act mandate that companies with more than 50 employees provide health insurance—most benefits are not required by law so what you receive will vary. What information actually shows up on your paycheck will also vary depending on employer and state of residence.

So let's run through a few of the most common deductions.

401(k) Deduction: According to the Employee Benefit Research Institute about half of American workers have employer sponsored retirement plans, many of them 401(k) retirement savings accounts. With a 401(k) you decide what percent of your salary to tuck away for retirement—most pros recommend 10% to 15%—you can save up to $18,000 this year pre-tax. The amount saved in the relevant pay period is removed from your gross pay and generally appears on your paycheck, as often does the amount saved so far this year. Your paycheck may also show your employer's matching contribution. If you did not select a saving rate you may have been auto-enrolled in your company plan at a rate high enough to receive the match.

Health Insurance Payment: Employers are required to pay 50% of the cost of health insurance, beyond that it is at their discretion how much of the expense to pass on to employees. In some cases employees who earn more pay more. Most premiums are paid pre-tax. In 2013, the most recent year available, the average annual premium for single coverage was $5,571 with workers asked to contribute $1,170, according to the Kaiser Family Foundation. This dynamic is expected to shift as the effects of the Affordable Care Act set in and health savings accounts increase in popularity.

Transit Benefits: To offset the cost of getting to and from work you may be able to pay for some or all of your commute pre-tax. You get up to $130 a month for transit, $250 a month for qualified parking and $20 bicycle commuting. In most locations you can only get the transit tax benefit if your employer offers it. So you're basically throwing away money if you don't do it. WageWorks, a company that helps employers administer this benefit, estimates saving an average of 30% on commuting costs this way. Employers save as much as 7.65% per participant from reduced payroll taxes. (For more on commuter benefits see, Commuter Tax Break Parity For 2015 Still Uncertain)

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* This story was originally published on January 4, 2016. It has been updated and republished for this series.
This article was written by Samantha Sharf from Forbes and was licensed as an article reprint from March 1, 2016. Article copyright 2016 by Forbes.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third-party provider of the reprint permission and Fidelity Investments are independent entities and not legally affiliated.
The images, graphs, tools, and videos are for illustrative purposes only.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917.
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