Decoding your paycheck: What recent college grads should understand

Recent college grads and entry-level job seekers are often excited to get that first paycheck. But they are also shocked when they suddenly realize the amount of that check may not be what they thought it would be. Remember when Rachel from Friends sees her first paycheck? (“Who is FICA and why is he getting all my money?“) Understanding how to decode your paycheck can help recent college grads become fiscally responsible.

“Educating yourself on how to read your pay stub and understand the information it contains can be the key to effective money management and proper budgeting,” says Brian Michaud, Senior Vice President, Client Service, ADP TotalSource.

Below, Michaud helps decode your paycheck, and understand just where all your money goes:

Gross and Net Pay
The two main components to understand are Gross Pay and Net Pay:

• Gross Pay: Gross pay is the total amount of wages you’ve earned for the pay period (a pay period is determined by your employer). This is typically bi-weekly or monthly. It’s your regular pay plus any other wages you earn, such as overtime pay or bonuses. Your taxes are based on gross pay.
• Net Pay: Net pay is the amount of money you actually receive on payday, or your “take home pay.” It’s your gross pay minus all deductions and all federal, state, and local taxes.

The basic components of a paycheck

• Federal tax: When you are first hired by your employer, you are required to fill out a Form W-4. This form covers any tax that you may owe to the Federal government come tax time. It is deducted incrementally from each paycheck, and varies depending on how many exemptions you claimed.
• State tax:  If your state has a tax, this amount is deducted from your paycheck the same way as Federal tax to cover the amount of tax that you may owe to the state when your tax return is filed.
• Local Tax: Although rare, a local tax is sometimes applied to employees of certain cities, counties or school districts. For example, if you live in New Jersey, but work in New York City, you will be required to pay not only New Jersey state tax, but also New York City tax on your earnings.
• FICA:  FICA stands for Federal Insurance Contributions Act and refers to amounts deducted for Social Security and Medicare taxes.
• Retirement Plan Contributions:  Plans such as 401(K) or 403(B) retirement savings plans will deduct the percentage you decide to contribute from each paycheck.

Here are a few items that you might find on your paycheck stub:

• Insurance Deductions:  This is the monthly payments for such types of insurance as health (medical and dental) and life insurance.
• Leave Time:  This includes vacation hours or sick hours. Most employers will detail how many hours have been used to date, and how many hours are remaining for the calendar year.
• Childcare Assistance: If offered by your employer, this amount may appear on each paycheck as a pre-tax benefit.
• Year-to-date (for pay and deductions): The year-to-date fields on your paycheck stub show how much you have paid toward a particular withholding at any point in the calendar year.
• Important Notices: Employers often use the paycheck stub to communicate important pieces of information to their employees, such as wage increases or notifications about tax filings.

Related: How the new overtime laws will affect interns and recent college grads

Understanding pre-tax contributions/savings
In a 401(k), you contribute “pretax” dollars, which means your contributions are taken from your paycheck before your income is taxed. This matters because, with that contribution set aside from the total paycheck before taxes, a smaller amount is taxed thereafter. Depending on your tax bracket, this could lower your taxable income while simultaneously saving money for retirement.

Suggestions for recent college grads

• Have a conversation with your parents: Determine what your taxation status is. Based upon the timing of your job, you may still qualify as a dependent for their taxes. Have a conversation regarding the standard dependent deduction vs. filing on your own based on the timing of getting the job, says Michaud.
• Review benefits: Along those same lines, make sure that you are reviewing benefit offerings with your parents.  If you are under 26 years old, compare the cost and benefits offered by your parent’s plan to your employer’s plan, and what is available on the public health care exchanges. You might qualify for a credit on the exchange, says Michaud.
• Calculate withholdings: Make sure that you calculate appropriately for Federal, State and, if applicable, Local tax withholding. Review your taxation calculations and ensure that you don’t under or severely over withhold. Federal taxation and state taxation can have very different rules and rates.

Many recent college grads are only concerned about the bottom line of their paycheck – the take home pay. But understanding where your hard-earned money goes, and how to maximize savings, is a good start for recent college grads planning for the present and future.

“Knowing where your money is going can help you stay on top of your finances and make the most of your hard-earned paycheck,” says Michaud.

Want to keep up on the latest career and job search tips and trends for recent college grads? Stay connected to College Recruiter by visiting our blog, and connecting with us on LinkedIn, Twitter, Facebook, and YouTube.

About Brian Michaud, Senior Vice President, Client Service, ADP TotalSource®
Brian Michaud is senior vice president of ADP TotalSource®, ADP’s Professional Employer Organization (PEO).  He and his team manage the company’s Human Resources Business Process Outsourcing (HRBPO) practice for small to midsized business owner clients, which delivers HR management, benefits administration, time and attendance, and payroll services as one Human Capital Management solution. Michaud started with ADP in 1991 as a sales representative for its Small Business Services business and joined the TotalSource business in 1999.