When someone asks "how much do you make?", which number do you give? Understanding the difference between and is essential for budgeting and financial planning.
Gross income is your total earnings before any deductions. This is:
- The salary in your job offer
- What you might tell people you "make"
- The bigger number
If your job pays $60,000 per year, that's your gross income.
Net income (also called "") is what actually hits your bank account after deductions:
- Federal income tax
- State income tax (in most states)
- Social Security tax (6.2%)
- Medicare tax (1.45%)
- premiums
- Retirement contributions (401k)
- Other benefits
If your gross is $60,000, your net might be $45,000-$48,000 depending on your situation.
Why This Matters
For budgeting: Your should be based on net income, not gross. You can't spend money that never reaches your account.
For job offers: A $60,000 salary sounds great until you realize you'll take home closer to $45,000.
For tax planning: Understanding deductions helps you estimate your tax burden and optimize your situation.
A Real Example
Let's break down a $60,000 salary in a typical scenario:
| Amount | |
|---|---|
| Gross Annual Salary | $60,000 |
| Federal Income Tax (~12% effective) | -$7,200 |
| State Income Tax (~5%) | -$3,000 |
| Social Security (6.2%) | -$3,720 |
| Medicare (1.45%) | -$870 |
| Health Insurance | -$2,400 |
| 401(k) Contribution (6%) | -$3,600 |
| Net Annual Income | $39,210 |
| Net Monthly Income | $3,268 |
Your $60,000 job actually pays you $3,268 per month. That's the number that matters for budgeting.
Pre-Tax vs. Post-Tax Deductions
Pre-tax deductions (reduce your taxable income):
- Traditional 401k contributions
- Health insurance premiums
- contributions
- FSA contributions
These lower your tax bill. A $3,600 401(k) contribution doesn't cost you $3,600—it costs less because you're not taxed on that money.
Post-tax deductions:
- Roth 401(k) contributions
- Some
- Wage garnishments
These come out after taxes are calculated.
Reading Your Pay Stub
Your pay stub shows all deductions. Key sections:
- Gross pay: Your earnings before deductions
- Taxes: Federal, state, Social Security, Medicare
- Before-tax deductions: 401(k), health insurance, HSA
- After-tax deductions: Roth, other benefits
- Net pay: What you actually receive
Review your pay stub at least once a year to understand where your money goes.
Common Mistakes
Mistake 1: Basing your on gross income You'll overspend because you're planning with money you don't have.
Mistake 2: Ignoring retirement contributions in net income Your 401(k) contribution reduces your net pay, but it's still YOUR money—it's just being invested.
Mistake 3: Not adjusting tax If you get a huge refund or owe a lot at tax time, adjust your W-4.
The Bottom Line
- Gross income: What you earn
- Net income: What you keep
- Budget with: Net income
- Goal: Maximize the gap between gross and net going to savings/investments (401k, HSA) rather than taxes