Payroll deductions are amounts that are automatically taken off employees’ salaries or wages on a monthly or yearly basis to cover various financial obligations.
Depending on where you’re based, your position and even personal preferences, the nature and amount of payroll deductions vary from one person to the next. Furthermore, there are various different types of payroll deductions, some of which are mandatory and others that are optional.
Most companies use payroll software to calculate deductions to make the process easier and to lower the chances of accidentally introducing errors.
Different Types of Payroll Deductions
When differentiating between different types of payroll deductions, the first distinction is between mandatory and optional deductions, but it’s more complicated than that.
In essence, there are five types of payroll deductions – income tax, pre-tax deductions, post-tax deductions, statutory deductions and voluntary deductions.
- Income Tax: Income tax is the main mandatory deduction and it’s also normally one of (if not the) largest deductions that’ll be withheld from employees’ paychecks. Employers calculate income tax based on the employee’s earnings and tax code (if you’re based in the UK) or filing status (in the US). Generally speaking, income tax is progressive, so you’ll pay more tax if you earn more. Employers are responsible for submitting these deductions to the tax authorities.
- Pre-Tax Deductions: This is an amount that’s subtracted from an employee’s gross income before taxes are applied, so essentially, it ends up reducing income tax. There are various types of pre-tax deductions including contributions to things like retirement plans, pension plans flexible spending accounts.
- Post-Tax Deductions: Post-tax deductions are, as the name suggests, amounts that come out of an employee’s paycheck after income tax has been applied. This tends to include voluntary expenses like union dues, charitable contributions and some types of insurance premiums that don’ qualify for pre-tax treatment. Now, post-tax deductions don’t reduce taxable income, but they do allow employees to manage specific payments directly from their wages.
- Statutory Deductions: Statutory deductions depend on where you’re based, but they’re mandatory contributions that employees are required to pay by law. For instance, in the UK, this includes National Insurance contributions (NICs) that go towards public services including state pensions. In the US, on the other hand, these deductions would cover Social Security and Medicare taxes (FICA taxes).
- Voluntary Deductions: Voluntary deductions are amounts that employees actively choose to have taken from their paychecks, normally contributing to benefits or services. For instance, this could include contributing more than the statutory requirement for retirement contributions. This is often seen as a good way to ensure long-term financial well-being.
It’s always a good idea to be fully aware of exactly what deductions you’re required to pay, especially when accepting a new job and negotiating a salary, as payroll deductions can really add up and will significantly impact the amount of money you end up walking away with every month.
How Are Payroll Deductions Calculated?
Most companies use either payroll software or specialised accounts to calculate deductions based on tax laws and employee preferences.
The calculation starts off with the employee’s gross earnings (that is, the amount before deductions). From there, pre-tax deductions are applied, then mandatory deductions like income tax are subtracted and they’re followed by post-tax and voluntary deductions.
For instance, if a specific employee earns £2500 a month and has pre-tax deductions of £200, the employee will only be taxed on £2300 rather than £2500.
All the details regarding payroll deductions are included on employees’ pay stubs (or pay slips) which outline how much has been deducted and for what.
