A guide to common paycheck deductions and withholdings

You work hard for your money, but when your paycheck comes, you may notice that you don’t get to keep it all. Why does your take-home pay shrink so much? And what do all those deductions mean? Generally, the money withheld from your paycheck goes to programs you may benefit from when you retire. Here’s a brief guide to help explain it further.

Federal withholding 

Federal withholding is the money the federal government takes to meet spending and interest payments. In case the funds aren’t available when taxes come due on April 15, the federal government requires pay-as-you-go withholding. FICA is another federal withholding that stands for Federal Insurance Contributions Act. FICA is made up of two taxes — Social Security and Medicare. Social Security may show up on your paycheck as OASDI. This stands for Old Age, Survivors, and Disability Insurance. These are payments into the mandated retirement savings program for when workers retire. OASDI also provides benefits to survivors of workers and disabled workers. Your employer makes a matching payment.

Medicare withholding 

Medicare withholding supports health care for retirees and might appear as FICA-HI on your paycheck. Employees and employers alike contribute 1.45% of pay.¹ Further, employees who have wages over $200,000 (single filers) and $250,000 (joint filers) need to pay an additional 0.9% Medicare tax on their wages that are above these thresholds.² There’s no employer share to this additional Medicare tax, but employers must withhold it from applicable employees’ paychecks.

State tax 

There are only nine states that don’t tax wage income: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.³ Americans in other states may see withholdings for state income tax, which of course vary from state to state.

Local tax 

Some working Americans are required to pay local income taxes in addition to federal and state income taxes. If you fall into this category, you may see a deduction for taxes levied by a local government. You may also see any number of other deductions or withholdings, many of which are voluntary, such as 401(k) contributions and employer health care insurance premiums.

401(k) contributions

As stated above, 401(k) contributions differ from the previous deductions mentioned because they are voluntary, not mandatory. And while 401(k) contributions aren’t required, they can make a big difference to your future financial picture. A 401(k) is a qualified plan that allows you to contribute a portion of your paycheck before tax withholding.⁴ In some cases, your employer may match what you contribute up to a certain percentage. Withdrawing money from the account before age 59 1/2 triggers penalties, but after that age the IRS allows withdrawals without penalty.⁵ Since 401(k) contributions are separate from your bank account, this can be an easier way to start building your retirement fund.

It's important to note that although 401(k) contributions are voluntary, you may be automatically enrolled in your employer’s plan. The SECURE 2.0 Act passed by Congress created mandatory automatic enrollment starting in 2025. This means that all new 401(k) plans must automatically enroll eligible employees at a minimum contribution rate of 3%. Automatic contribution increases are also part of this law, which means the contribution to your 401(k) will automatically increase by 1% each year until you’re contributing at least 10% of your salary. You can control your contribution rate, though, and adjust these numbers.⁶

Even small businesses can enjoy the benefits of a 401(k) plan. If you’re a one-person business, you might want to consider opting into a Solo 401(k) Plan, which may provide opportunities to increase your tax-deductible retirement plan contributions.

The paycheck’s journey from “gross pay” to “net pay” may make it a little lighter, but when you consider the important places your deductions are going, the practice may seem a bit brighter.