What is Net Pay?
Net pay, also commonly known as take-home pay, refers to the amount of salary that employees get after all the necessary deductions. Thus, it is the amount that employees get as their paychecks. The deductions can be on account of tax withheld as per laws, employee’s contribution to retirement plans, insurance plans, pension plans, and deductions for any other employee benefit plan that the employees opt for.
Explanation
The companies usually refer to the gross pay when they talk about salary. This is the amount of salary that a company incurs for its employees. Apart from gross pay, companies also incur expenses concerning employee benefit plans such as retirement plans, pension plans, insurance plans, etc. which also form part of employee benefit expenses for the company.
However, the employee doesn’t have the entire amount of gross pay. Certain deductions are made from the gross pay, and the resultant amount paid to the employee is known as net pay. These deductions can be on account of tax withheld and employee’s contributions to various employee benefit plans such as retirement plans, pension plans, etc.
How to Calculate?
It can be calculated using the following formula:
Thus, to calculate, you need to reduce the value of deductions from the gross pay. The companies usually mention the amounts of deductions that it makes from the salary and bifurcation of the amounts.
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Examples of Net Pay
Let us understand the calculation with the help of examples.
In this example, the deductions have been made from the employee’s salary on account of state tax, federal tax, contribution to the retirement plan, and contribution to the insurance plan. The total deductions amount to $720. It is calculated by reducing the value of deductions from the gross pay amounting to $4,000. The resultant net pay comes out to be $3,280.
Importance
The concept of net pay is important from the viewpoint of employees. Although their gross pay may be higher, the amount of net pay will always be lower. Thus, employees are much more concerned with the net amount since it is the amount that they are going to get as their paychecks.
The amounts that are deducted on account of employee benefit plans such as retirement and pension plans are not immediately received by the employees. The same is received after the conditions are met by the employees attached to such plans. Therefore, it becomes important as it reflects the amount that employees receive as paychecks immediately.
Net Pay vs. Gross Pay
| Basis of Difference | Gross Pay | Net Pay | ||
| Definition | Gross pay refers to the total salary that an employee earns for his employment services without reducing any deductions. | Net pay refers to the portion of gross pay employees receive as paychecks after accounting for all deductions. | ||
| Calculation | It is calculated by adding all components of salary such as basic pay, allowances, bonus. It can also be calculated by reducing the employer’s contribution to employee benefit plans from the CTC (Cost to Company). | It is calculated by reducing the value of deductions from the gross pay. Deductions include taxes withheld and the employee’s contribution to employee benefit plans. | ||
| Amount comparison | Gross pay is always greater than or equal to net pay. Both will be equal in case there are no deductions. | The amount of net pay is always lower than or equal to gross pay. Both will be equal in case there are no deductions. | ||
| Treatment of taxes | The amount of taxes withheld on employee’s pay is not reduced in gross pay. | The amount of taxes withheld on employee’s pay is reduced in gross pay. | ||
| Impact on cash flow | It doesn’t represent the amount that affects the cash flow of the business. | It represents the amount that impacts the cash flow of the business. |
Advantages
It offers the following two advantages for the employees and employers:
- For the employer, it represents the amount that the business requires to pay to its employees. Therefore, it helps the company to plan its cash flows and arrange the required funds.
- For the employees, it represents the value of funds that the employees get as paychecks. They receive this amount in their bank accounts and can plan their spending based on the amount of net pay that they receive.
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