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While both gross and net income refer to the money you earn, there are key differences:
- Gross income is the money you earn from your hourly wages, salary, commissions, and bonuses.
- Net income is the money you’re left with after taxes are paid and any deductions for health insurance or other benefits are taken. .
Gross income details: How it works
Your gross income is the total amount of money you earn.
If, for example, you earn a gross salary of $52,000 a year, and your company pays you on a weekly basis, your gross income is $1,000 a week.
If you receive an hourly wage, you can calculate your gross income by multiplying the number of hours worked in your payroll period by your hourly wage.
For example: If you earn $13.50 an hour, you work 24 hours a week and you receive a paycheck every two weeks, your gross income per pay period is $648 (or $13.50 multiplied by 48 hours).
Net income details: How it works
Your net income is your gross income minus everything that your employer or the government withholds from your paycheck.. Net income is commonly referred to as take-home pay. When your employer processes payroll, deductions will be made for federal and state and local taxes, Social Security and Medicare. If you’re self-employed, you’re responsible for paying these taxes on your own, usually every quarter. The amount left after taxes is your net income.
You may also have other deductions that leave you with a lower net income. Some of the most common deductions include premiums for dental, vision, short-term disability and health insurance. There are also retirement plan contributions if you participate in your employer’s retirement plan.
Here’s how you can calculate your net income:
If you earn a gross income of $1,000 a week and have $300 in withholdings (accounting for taxes and other deductions), your net income will be $700.
The same applies to hourly employees. You can take your gross earnings, subtract any pretax deductions, then multiply the remainder by one minus the tax rate you pay (the Federal Insurance Contributions Act, or FICA, tax rate, which consists of Social Security and Medicare taxes, is 15.3 percent).
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 15.3 percent tax rate).
How gross and net income can impact your budget
The higher your gross income, the higher your tax liability will be, depending on your marital status, deductions and other qualifying credits.
Gross income might also affect how you invest your money. Many employers offer retirement plans where you can contribute by having deductions made from each paycheck. Some of these contributions are pretax, giving you the advantage of saving for retirement while lowering your tax liability.
Say you earn $1,000 each paycheck and contribute 4 percent of your earnings (pretax) to your employer’s 401(k) plan. That’s 4 percent you don’t need to pay taxes on now since you are devoting these funds to investing 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 to categorize your spending transactions, identify ways to cut back and improve your financial health.
Your net income also acts as an indicator of the state of your finances. After you factor in all necessary expenses, the remainder is your discretionary income. You can use your discretionary income to save, invest, pay down debts, or for travel and entertainment.
Steps you can take
If you don’t have much net income remaining after your necessary expenses, there are a few things you can do.
First, make sure your withholdings are correct with your employer. When starting a salaried job, you will need to complete a Form W-4, known as the Employee’s Withholding Certificate. This form 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 household, you should complete a new W-4. Doing so ensures the right amount of taxes are being taken from your paycheck. Adding a new dependent could reduce the amount of taxes you pay, therefore increasing your net income, for example.
Another option is to consider what benefits are deducted from your paycheck. Each year, your employer has an open enrollment period, where you can make changes to your insurance. You can also decrease or increase your retirement contributions based on how much money you have remaining after deducting necessary expenses from your net income. It makes sense to withhold the maximum amount you can contribute to tax-advantaged retirement accounts, as this both lowers your taxes and helps you build a nest egg for your retirement.