What Is Net Pay? - Definition & How to Calculate

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  • 0:01 Definition of Net Pay
  • 0:35 How to Calculate Net Pay
  • 3:34 Example of Net Pay
  • 4:13 Lesson Summary
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Lesson Transcript
Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

This lesson will define net pay, a term typically used by working individuals. How to calculate net pay will be explained, and an example will be explored.

Definition of Net Pay

Have you ever been in the middle of a conversation about finances, and someone mentioned their net pay? Perhaps the term used was 'take-home pay.' Individuals commonly mistake net pay and take-home pay with gross pay, and there are vast differences that should be understood.

Net pay is the amount one receives after taxes and deductions have been withheld during a pay period. Both taxes and deductions can include items of various natures, and this lesson will go into greater detail about which items are relevant when calculating net pay.

How to Calculate Net Pay

Using a calculator, a spreadsheet, or a pencil and paper will all work for net pay calculation. It is important to keep in mind that this calculation is generic in nature, and may differ from your own.

The formula to follow is:

gross pay - taxes withheld - deductions withheld = net pay

Start with the gross pay, or salary. For purposes of an example, let's assume an unmarried individual lives with an annual salary of $48,000. Every two weeks, the gross pay is $2,000.

Let's start with taxes.

In 2014, the FICA, or Federal Insurance Contributions Act, tax responsibility for this individual was 7.65%; of this, 6.20% is Social Security tax, and the remaining 1.455% is Medicare tax. The employer responsibility is also 7.65%. However, the Social Security tax has a wage base limit, and in 2014 that limit was $117,000. Wages over $117,000 do not have the Social Security tax.

In our example, the individual is responsible for 7.65%, or $153.00.

Upon being hired, the employer requested our sample employee to complete IRS Form W-4. This form indicates to the employer how much tax should be withheld. After completing and returning this form to the employer, the employer calculates the amount to be withheld from the employee's paycheck, per IRS guidelines. The employee also completes a similar form at the state level, provided he or she resides in a state that levies a state income tax.

Next, let's look at deductions.

One deduction may be a retirement account. For our example, we will assume the individual contributes 3% of pay to the retirement account. 3% of $2,000 is $60.00.

Furthermore, health, vision, and dental insurance are all examples of additional deductions that may be withheld from an employee's gross pay. In our example, the individual is responsible for health insurance at a cost of $100.00 per pay period. Court-ordered withholdings may also be deducted from paychecks.

To summarize, items that may be withheld from a paycheck include:

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