When an employer takes money out of an employee's paycheck, it's called Payroll deduction, and it's one of the steps in the payroll processing performed by a firm's HR/accountants department.
Whether for medical expenses, insurance premiums, garnishment of retirement funds, or child support, payroll deductions are often viewed as a positive perk of employment.
A percentage of your paycheck, though, may be taken out every week whether you want it or not because the federal or state government sets it. In this sense, we can think of income tax, 401(k), and social security tax. Consequently, it is essential to gain a deeper understanding of how payroll deductions are determined.
How do Payroll Deductions Work?
According to the applicable tax laws, court orders, withholding information provided by your company, or any mutual contract between you and your employer are the common determining factors for calculating Payroll deduction.
The state law can differ depending on your workplace location, as only some states collect income tax.
"Pre-tax deduction" refers to the amount taken out of a paycheck before tax calculations. It is a great perk to get the deduction.
Accordingly, group term life insurance, health insurance, retirement plans, etc., are all benefits of pre-tax deduction. In addition, the Internal Revenue Service controls the pre-tax amount contributed to a 401(k) plan annually.
On the other hand, post-tax deductions include taking money out of your paycheck after taxes. However, workers do have the option not to contribute to the post-tax deductions.
Hence, wage garnishment, alimony payments, child support, and disability insurance premiums are all benefits of post-tax deductions.
Which Payroll Deductions are Mandatory?
Employees must make mandatory payroll deductions out of their paycheck and are not allowed to opt out. Below is a list of mandatory payroll deductions for residents of the United States:
U.S. Social Security taxes
Civil Service Retirement
Foreign Service retirement
Federal Employees Health Benefits (FEHB)
Federally mandated income tax withholding
Federal Employees’ Group Basic Life Insurance (FEGLI)
Child support payments
Social Security, Premiums, and Medicare contributions (FICA taxes)
Personal Services contractors (PSCs)
U.S. Federal, State, and Local income taxes
Retirement, health, and life benefits when local law requires coverage
Here are some explanations of the required taxes.
1. Federal Insurance Contributions Act (FICA) Taxes
All employees have Medicare and Social Security contributions withheld from their paychecks through the Federal Insurance Contributions Act (FICA). Compared to Social Security, Medicare costs 1.45% of gross pay.
When your annual salary is over $147,000, you no longer have to pay into Social Security. The first $147,000 of an employee's yearly salary is exempt from Social Security tax withholding and employer contribution.
An additional 0.9% Additional Medicare Tax must be withheld from an employee's pay after their yearly salary exceeds $200,000.
2. OASDI or the Old-Age, Survivors, and Disability Insurance
It serves as the program's official term for Social Security payouts. The OASDI tax is regarded as being included in the FICA tax.
3. Wage Garnishments
A court or government body may issue an order for wage garnishment if an employee owes money. Garnishments on wages are post-tax deductions.
Wage garnishments can take the following forms:
Credit card debts
4. State Income Tax
All states, except nine, impose income taxes on employee wages. They either have many brackets or a set rate applied to all income. Depending on where each employee lives or works, your payroll software should be able to handle any appropriate state income tax for them.
5. Federal Income Tax
Tax on personal or business income imposed by the Internal Revenue Service is known as the federal income tax, or FIT. It is usually the most significant deduction on the average person's income statement.
There are seven tax brackets for the federal income tax, ranging from 10% to 37% at the top. Their wages determine the amount deducted from an employee's salary and the details they supply on Form W-4.
Which Payroll Deductions are Voluntary?
Your payroll deduction will contribute to perks like health insurance and a 401K plan offered by your employer. Depending on the type of deduction, these voluntary deductions may be pre-tax or post-tax.
You may deduct some benefits according to the following examples:
Medical, dental, or vision health insurance plans
Charitable to employer-sponsored charitable giving plans
U.S. Savings Bond purchases
Tuition or professional certification fee deductions
401(k) plan, IRA, or other retirement savings plan contributions
Flexible spending account or pre-tax health savings account contributions
Life insurance premiums (often sponsored by the employer
Here are the explanations of a few voluntary payroll deduction terms.
1. Individual Retirement Account (IRA)
Employees participate in this sort of retirement plan with a financial institution by opening an individual retirement account (IRA), either a standard or Roth IRA. Then, each pay month, the employee's company deducts the amount the worker has designated for their IRA and sends it to the designated financial institution.
There is no employer match, and the yearly IRA annual contribution is only $6000 (for those 50 and older, the amount is $7000), making this less complex and more accessible for the company to administer than a 401(k). However, employees are likely to find this less appealing.
2. Group Term Life Insurance
It depends on the plan and the quantity of coverage whether or not the premiums for group term life insurance are taxable.
Employees can save for their retirement through a 401(k) plan. However, due to an IRS increase, the maximum 401(k) contribution per year will be $20,500 beginning in 2022. An additional catch-up payment of $6500 is available to employees who are 50 or older.
Employer matching contributions to 401(k) plans is another way that employers may show they care about their workers' financial futures. Employee 401(k) contributions are taxable for FICA purposes only and not for income tax purposes.
Calculating how much money is deducted from the paycheck is not an arduous task to do. Follow the instructions below to calculate yours:
To calculate Social Security tax, deduct 6.2% of your salary or wages up to the maximum annual salary or compensation of $147,000. If your yearly salary exceeds $147,000, you do not need to withhold Social Security tax.
Medicare tax will be withheld at 1.45% of the adjusted gross salary.
Earnings over $200,000 annually are subject to an extra 0.9% Medicare tax deduction.
You can write off your 401(k) payments.
If the employee has filled out a W-4, their federal income tax should be withheld at the appropriate rate from their paycheck.
Make sure you deduct state income tax following the state's income tax regulations.
Total gross income is reduced by post-tax deductions such as garnishments and Roth IRA contributions.
Note: Cafeteria plan contributions and other voluntary contributions that are not deductible for FICA or income tax purposes can also deduct. We'll refer to this sum as the "adjusted gross pay" for simplicity's sake.