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 wages before your employer applies withholdings such as taxes, health insurance and retirement plan contributions.
- Net income is the money you receive after your withholdings are deducted.
Gross income details
Your gross income is the total amount of money you earn during a payroll period.
If, for example, your job earns you a gross salary of $52,000 a year, and your company pays you on a weekly basis, your gross income will be $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.
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
Your net income subtracts all of your withholdings from your gross income. 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.
You may also have other deductions that lower your 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.
With all of this in mind, there are ways you can calculate your net income. If you earn a gross income of $1,000 a week but 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 all necessary expenses from your net income, the remainder is your discretionary income. You can use your discretionary income to save, invest, pay down debts, or for such “fun” expenses like 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 certificate 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 head of household, you should complete a new W-4. Doing so provides a more accurate depiction of your finances while allowing you to have less tax withheld from each paycheck, thereby increasing your net income.
Another option is to consider the deductions from your paycheck. Each year, your employer has an open enrollment period, where you can make changes to your insurance. You can also lower 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 as well as providing more funds for your retirement.