Understanding the difference between gross and net income can be helpful for tracking and improving your financial situation. While both gross income and net income refer to the money you earn, there are key differences:
- Gross income is the total amount of money you earn from your hourly wages, salary, commissions, bonuses, etc.
- Net income is the money you’re left with after taxes and any deductions for health insurance or other benefits are taken out.
Gross income: How it works
Your gross income is the total amount of money you earn. If, for example, you earn a gross salary of $52,000 a year, and your company pays you on a weekly basis, your gross income is $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.
For example, 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: How it works
Your net income is your gross income minus everything that your employer or the government withholds from your paycheck. Net income is commonly referred to as take-home pay. When your employer processes payroll, deductions will be made for federal, state and local taxes, and Social Security and Medicare. If you’re self-employed, you’re responsible for paying these taxes on your own, usually four times a year.
You may also have other paycheck deductions that reduce your net income. Some of the most common deductions include premiums for dental, vision, short-term disability and health insurance. If you participate in your employer’s retirement plan, your contributions also reduce your net income.
If you earn gross income of $1,000 a week and $300 is taken out for taxes and other deductions, then your net income is $700.
How gross and net income can affect your budget
The higher your gross income, the higher your tax liability will be, depending on your tax-filing status (married, single, etc.), deductions and credits. If your gross income is equal to or below the standard deduction amount — $14,600 in 2024 and $15,000 in 2025 for single filers — you might not be required to file taxes at all.
Gross income also plays a part in your savings rate. Many employers offer retirement plans and, if you participate, those contributions are deducted from your paycheck. If you elect to contribute, say, 5 percent to retirement, that amount is typically based on your gross income. Often, retirement plan contributions are pretax, meaning you stash the money away for retirement without paying tax on it through your current paychecks. That gives you the advantage of saving for retirement while lowering your tax liability. (Once you retire and start taking withdrawals from a pretax retirement plan, you’ll owe income tax on your withdrawals.)
Say you earn $1,000 each paycheck and contribute 5 percent of your gross earnings, pretax, to your employer’s 401(k) plan. You don’t need to pay taxes on those contributions now since you’re saving those funds to invest for your retirement. In other words, those contributions reduce your gross income, and thus reduce your income subject to tax in the current year.
After taxes, insurance and voluntary deductions are accounted for, your take-home pay is equivalent to your net income. This calculation of your income is what you’ll use when budgeting. A popular budgeting strategy — the 50/30/20 budget rule – is a way to divvy up your net income, with 50 percent going toward necessities, 30 percent to wants and the remaining 20 percent to savings.
Using your net income as the basis for your budget is important because it’s a more accurate picture of how much money you have available to pay for necessities, such as mortgage or rent, utilities, home insurance and auto insurance, groceries and car payments.
Your net income also acts as an indicator of the state of your finances. After you factor in all necessary expenses, the remainder is your discretionary income. You can use your discretionary income to save, invest, pay down debts, or pay for 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 job, you’ll need to complete a Form W-4, known as the Employee’s Withholding Certificate. This form helps employers determine how much money to withhold for your taxes.
When you have a major change in your life, such as having a baby or becoming the head of a household, you should complete a new W-4 form. Doing so ensures the right amount of taxes are being deducted from your paycheck. Adding a new dependent could reduce the amount of taxes you pay, therefore increasing your net income, for example.
Another option is to consider what benefits are deducted from your paycheck. Each year, your employer has an open enrollment period, where you can make changes to your insurance. Also, generally at any point during the year you can increase or decrease your retirement contributions based on how much money you have remaining after deducting necessary expenses from your net income. It makes sense to contribute the maximum amount you can to tax-advantaged retirement accounts, as this both lowers your taxes and helps you build a nest egg for your retirement.
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