Although gross income and net income refer to the money you earn, there are key differences:
- Gross income is the money you earn from your paycheck before your employer makes deductions such as taxes, health insurance, and pension contributions.
- Net income is the money you receive after deducting your deductions.
Gross income details
Your gross income is the total amount of money you earn during a pay period.
If, for example, your job earns you a gross salary of $ 52,000 per year and your business pays you on a weekly basis, your gross income will be $ 1,000 per week. If you are paid an hourly wage, you can calculate your gross income by multiplying the number of hours worked in your pay period by your hourly wage.
If you earn $ 13.50 an hour, work 24 hours a day, and receive a paycheck every two weeks, your gross income per pay period is $ 648 (or $ 13.50 multiplied per 48 hours).
Net income details
Your net income subtracts all your withholdings from your gross income. Net income is commonly referred to as “net earnings”. When your employer processes payroll, deductions will be made for federal, state and local taxes, Social Security, and Medicare.
You may also have other deductions that reduce your net income. Some of the more common deductions include dental, vision, short-term disability, and health insurance premiums. There are also contributions to the pension plan if you participate in your employer’s pension plan.
With all of this in mind, there are ways to calculate your net income. If you earn gross income of $ 1,000 per week but have $ 300 in deductions (including taxes and other deductions), your net income will be $ 700.
The same goes for hourly employees. You can take your gross income, subtract any pre-tax deduction, then multiply the remainder by one minus the tax rate you pay (the Federal Insurance Contributions Act tax rate, or FICA, which includes security taxes. social and health insurance, is 15.3 per cent).
Therefore, if you earn $ 648, you only pay FICA taxes and have no other deductions, your net income will be $ 548.86 (or $ 648 multiplied by 1 minus the tax rate of 15.3 percent).
How gross and net income can impact your budget
The higher your gross income, the higher your tax payable will be, depending on your marital status, deductions and other eligible credits.
Gross income can also affect how you invest your money. Many employers offer retirement plans that you can contribute to by making deductions from each paycheque. Some of these contributions are pre-tax, giving you the advantage of saving for your retirement while reducing your tax liability.
Suppose you earn $ 1,000 on a paycheck and contribute 4% of your earnings (before taxes) to your employer’s 401 (k) plan. That’s 4 percent that you don’t need to pay tax on now since you are spending those funds to invest for your golden years.
Meanwhile, net income refers to your take home pay. This is the income you use when budgeting and will help you determine how much money you have available for necessities such as mortgage or rent, utilities, home insurance, and auto insurance. , groceries and car payments. You can sign up for Bankrate’s myMoney at ccategorize your spending transactions, identify ways to reduce and improve your financial health.
Your net income also serves as an indicator of the state of your finances. After you factor in all the necessary expenses from your net income, the rest is your discretionary income. You can use your discretionary income to save, invest, pay off debt, or for “fun” expenses like travel and entertainment.
Actions you can take
If you don’t have much net income left after your necessary expenses, there are a few things you can do.
First, make sure your deductions are correct with your employer. When you start paid employment, you will need to complete a W-4 form, known as an employee’s withholding tax certificate. This certificate helps employers determine how much to withhold for your taxes.
When you have a major change in your life, such as having a baby or becoming the head of a family, you need to complete a new W-4. This gives a more accurate picture of your finances while allowing you to have less tax withheld from each paycheck, thus increasing your net income.
Another option is to consider deductions from your paycheck. Each year your employer has an open enrollment period, where you can make changes to your insurance. You can also reduce or increase your pension contributions based on the money you have left after deducting necessary expenses from your net income. It makes sense to withhold the maximum amount you can contribute to tax-efficient retirement accounts, as it both lowers your taxes and provides more funds for your retirement.