Work is a lot more than clocking in and out. It’s an opportunity to bond with colleagues, participate in the company culture, and grow personally and professionally.
At the end of the day, work represents a paycheck that allows people to maintain their hard-earned lifestyle. Although a salary isn’t the only value a job offers, monthly earning is a basic priority for most employees.
However, understanding how paychecks are calculated gets confusing fast. Deductions, taxes, and
benefit contributions are complicated, and they can sometimes lead to unfortunate surprises when direct deposit hits.
Net pay transparency is key to supporting team morale, productivity, and retention. Here’s a guide to pretax deductions, how net pay is calculated, and, most importantly, why sharing take-home pay calculations is synonymous with employee satisfaction and retention.
What is net pay?
Net pay refers to the earnings an employee takes home after all deductions are subtracted from their gross pay. This includes Federal Insurance Contributions Act (FICA) taxes, retirement plan contributions, and health insurance premiums, among other benefits and withholdings. An employee who earns $85,000 takes home a much lower annual net income once those deductions come out.
For employees, the difference between gross pay and net pay isn’t just numbers on a pay stub. It directly impacts how much money they have for monthly expenses, savings, and future plans.
Financial stability starts with financial clarity. This is where proper payroll management comes in. Employers with clear and transparent payroll procedures build trust and help employees thrive financially. When people know exactly what to expect at the end of each pay period, it translates to personal well-being and a more motivated workforce.
Gross pay vs. net pay
When discussing compensation with your workforce, start by laying out the differences between gross pay and net pay.
Gross pay is the total amount an employee earns before any deductions. Most likely, this gross salary is the compensation that appears in the job advertisement. Additional earnings are the extras on top, including bonuses, commissions, and overtime pay.
Net pay, on the other hand, is what workers actually take home after deductions. This is the number that shows up on their paycheck or deposited into their bank account. The most common deductions include:
Federal income tax
State income tax
Local income tax
Social Security tax
Medicare tax
Employers can also offer pretax deductions, which also come directly out of employees’ paychecks. Common pretax payroll deductions include:
Retirement contributions, including a 401(k), SEP IRA, or simple IRA
Health insurance premiums
Other healthcare benefits, including flexible spending accounts (FSAs) and health savings accounts (HSAs)
Insurance coverage, like life insurance
Gross wages are a “promise” figure — the total amount agreed upon for work in exchange for wages. Net pay is the “reality” figure — the real amount employees receive for daily expenses and future savings.
How to calculate net income in 4 steps
By breaking net pay down into four simple steps, you can easily determine how much an employee takes home. Although the below example reflects salaried employees, you can apply the same workflow to calculate net pay for hourly workers.
1. Calculate gross pay
Begin with the total gross pay. Add extras like bonuses, overtime pay, and sales commissions.
Imagine an employee earns an annual salary of $75,000 plus $7,000 in commissions. $82,000 is the figure you start with.
2. Subtract pretax deductions
Subtract all pretax deductions. These are deductions taken out of the paycheck before taxes and are referred to as the adjusted gross pay.
Let’s say the employee contributes $7,500 to their 401(k) and $3,000 for health insurance premiums. Subtract these amounts from the gross pay: $82,000 - $7,500 - $3,000 = $71,500.
3. Apply taxes
Now it’s time to calculate and subtract federal, state, and local taxes, as well as Social Security and FICA taxes. Withhold these based on the adjusted gross pay from the previous step. Remember, tax rates vary widely based on location, tax bracket, and other individual factors.
For simplicity, let’s assume the total taxes amount to 20% or $14,300. Subtract these amounts: $71,500 - $14,300 = $57,200.
4. Subtract post-tax deductions
Finally, subtract post-tax deductions to calculate net pay. This can include wage garnishments (deductions used to pay debts, including child support payments, loan defaults, or student loan repayments), union fees, and Roth IRA accounts.
Let’s imagine the employee has $1,200 in post-tax deductions. Subtract the following: $57,200 - $1,200 = $56,000.
Once you’ve gone through these four steps, you have net pay. In this example, the final take-home pay is $56,000. If you want to calculate monthly net pay, simply divide by 12 pay periods: $56,000 / 12 = $4666.
Why is it important to know net pay?
Explaining net pay to employees is an essential part of onboarding and ongoing salary adjustments. It’s more than just understanding if net pay is before or after taxes — though that’s a good place to start. The real importance of accurately calculating net pay lies in how it impacts personal and organizational financial planning.
Here are a few reasons why clear communication around net pay is important to employers and employees alike:
Reduces confusion
Medicare taxes, healthcare premiums, and federal income taxes add up. Even financially well-versed employees can get confused about how payroll deductions impact their final take-home pay.
If employees don’t fully understand their taxable income and net pay, they might overestimate their salary. This can lead to frustrations when they realize their paycheck doesn’t stretch as far as expected, which reflects poorly on the business. It can make salary negotiations difficult, cause job dissatisfaction, and lead to turnover when employees feel their take-home pay doesn’t align with their needs.
Nurtures financial wellness
Employees have responsibilities outside of work, including financial obligations. Whether paying bills or saving for a mortgage, they need to be able to budget effectively.
Good employers take their workforce’s
financial wellness seriously, from transparency around payroll taxes to advising on deductions that can lower their federal income tax withholding. And when employees feel like their financial interests are taken care of, it reduces stress and helps them bring their full selves to work.
Supports tax compliance
Employers are required to withhold taxes from their employees’ paychecks. Failure to calculate payroll taxes and net pay accurately can lead to hefty fines and lengthy litigation. Consistent best practices are a win-win for everyone.
Empower your team with financial flexibility
Employees rely on their company to support their financial well-being. When they have a clear understanding of their take-home pay, they can plan their finances more effectively. Knowing exactly how much they will have in their wallet helps them budget accordingly, reduce stress, and improve satisfaction.
EarnIn’s Earned Wage Access
tool builds on this foundation by offering flexible access to earnings, allowing employees to manage unexpected expenses between paydays and helping them gain greater control over their financial journey. Employees can access their pay the same day they work, starting at $2.99 per transfer to their bank account, with the ability to get up to $150 per day with a max of $750 between paydays.Empower your workforce with
EarnIn for business today.
Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.
EarnIn is a financial technology company, not a bank. Banking services are provided by our bank partners on certain products other than Cash Out.
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