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Anatomy of a paycheck

Learn about the deductions taken from your paycheck. Created by Sal Khan.

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Video transcript

What I wanna do in this video is go through the anatomy of a paycheck, or a pay stub, and the reason why I wanna do it is because I remember the first time that I had a paycheck, a proper pay stub as well that I was shocked by how little I was getting relative to how much I thought I was getting. So for example in this paycheck right over here, it's obviously a fictional one, my gross earnings are $3,000.00 this is what's typically quoted to you when you say how much you make in terms of either on a weekly basis, monthly basis, or annual basis, and we're assuming that this is a bi-monthly paycheck, so I get two paychecks a month like this, so I'm making roughly $6,000 a month gross earnings, but you see that the check here is not for $3,000. It is for $1,585, it's a little more than half of my gross earnings. So where did all of that money go? And the answer is it's going to the deductions over here. And these deductions could be categorized really into two buckets, the first several by law are things that you have to pay, and so many employers will typically take it out for you. And so these are statutory deductions, statutory, by law you have to pay these things. The first line right over here, and depending on who you are it could be different, but it's typically the largest statutory, typically the largest deduction taken out of your paycheck which is federal income tax. This is your contribution to the federal government to allow the federal government to run, and as you can imagine, as if either your gross earnings go up, if your taxable earnings go up, then this number typically is larger, and not only is it larger in absolute terms, but typically as you go into higher and higher tax brackets becomes a larger percentage of your total taxable earnings. Now the next line here, this is state income tax, most states have a state income tax, a few of them don't, but if you're in a state with state income tax this is your contribution to the operations of the state. And then these last two lines, this is social security and medicare and medicaid, in other videos we go into more depth of what these programs are, but these once again are statutory deductions to help fund these federal programs. Social security is going to be 6.2% of your gross earnings, and medicare/medicaid is going to be 1.45%. Now everything below that, at least in the case in this example right over here, could be considered voluntary deductions. Voluntary, now you might be wondering, why would anyone voluntarily take money out of their paycheck? Why wouldn't they wanna keep it? And the answer is, most of these voluntary deductions allow you to save, or pay for things on a pre-tax basis, which means you get to pay for these things, or save for these things without having to pay your incremental tax rate. So let's say this person, I guess it's me in this example. Let's say I'm in the 25% tax bracket, which means that incremental dollar that I earn I have to pay 25 cents, and let's just say that's just for federal income taxes, I have to pay 25 cents on that dollar. If I'm able to buy things on a pre-tax basis, I don't have to pay my taxes before paying for those particular expenses, I can just pay for them before paying taxes on those amounts, and so it's essentially a pretty nice savings and in other videos we'll go more into the details of it. But just to understand what these lines typically are many employers will provide insurance for you, but they'll require you to pay some of it. Sometimes they'll ask you to pay 10% of insurance, of the insurance cost for yourself and maybe 20% or 50% of your insurance cost for your family, so this line right over here is that, it's your contribution to pay your insurance premium, and your premium is just what you pay, what someone pays to the insurance company every month in order for you to have insurance, so your employer might be paying the bulk of it, but you also have some contribution right over here. The next line is a retirement savings plan, and this could be a 401K, this is something that you would contribute to so that you can save on a pre-tax basis. That's your incentive for doing it. Another incentive some people feel that hey look if I just, if the money's taken out before I have a chance to spend it, then that's going to force me to save, so it's pre-tax, it's typically pre-tax, and it's a nice way of enforcing discipline on savings. Now this next line is charity, a lot of employers often allow you to just, hey if you wanna contribute to a worthy cause, to take it out ahead of time from your income. Now charity is typically, is always tax-deductible, or I'll say typically tax-deductible, and so you might say, well why don't you just pay and deduct it later, but this just simplifies, this might simplify the process, and once again it might give you some discipline, so okay I'm gonna give a certain percentage of my income to charity every two weeks or every month. And then this last line here, at least for this particular pay stub, this health/childcare plan, many times you have available to you a flexible spending account where you could put money into kind of a bucket that could be used on a pre-tax basis either for healthcare costs that aren't covered by insurance, or for childcare costs, and so that's what, I guess, I am doing in this pay stub right over here. And so after paying everything I'm walking away with a little bit more than half of my gross earnings.