Gross vs. net income: What’s the difference?

When navigating the world of personal finance, especially as parents, it’s crucial to grasp the difference between gross and net income. Understanding gross vs. net income can significantly influence your family’s budgeting, saving, and overall financial health. Let’s break it down.

The basics of gross income

Gross income refers to the total earnings you generate for services performed before any payroll deductions are taken out. It’s also generally the number agreed upon when discussing compensation for a job. For example, if you earn a base annual salary of $50,000 before anything is taken out, then $50,000 is your gross income. Gross income can include things like: 

• Salary and wages: Your agreed-upon pay for your services, whether by the hour, annually, or by project. 

• Bonuses: Some employees receive bonuses for outstanding work or reaching specific targets. Bonuses are also considered part of your gross income.

• Commissions: This is particularly common in sales-related positions where you earn a percentage of the sales you generate. Any commission you earn in a given year will also be included in your gross income.

• Other sources: Other earnings like rental income, stock options, dividends, tips, or any other monetary gains you receive for work. 

Knowing your gross income is a great starting point. Still, it’s crucial to remember that this amount typically doesn’t reflect the actual dollar amount you will have after taxes and other essential expenditures. 

What is net income?

Net income is the amount of money you actually take home after all those mandatory deductions and taxes have been accounted for. It’s your “take-home pay”— the actual figure to focus on when budgeting for essential expenses, savings, and investments and determining things like disposable income. 

Note: If you’re self-employed, you must report your earnings to the IRS and Social Security and pay any required taxes. 

Deductions that affect net income

Various deductions can impact your net income significantly. Some of the major deductions include:

• Taxes: This includes federal, state, and sometimes local taxes. These deductions can significantly impact your net earnings. For example, federal income tax brackets range from 10% to 37% of earnings for individuals. Your income determines your tax bracket and which percentage will be deducted from your pay. 

• Social Security and Medicare contributions: These mandatory deductions fund government programs that provide benefits for retirees and people with disabilities.

• Insurance premiums: If you pay for any portion of your health, dental, vision, or other insurance, subtract those premiums from your gross income. 

• Retirement contributions: Many families contribute to retirement accounts like 401(k) or IRAs. Those tax-advantaged contributions will affect your net income, so account for them in your budgeting as well.  

Why the difference matters

Understanding gross vs. net income is essential to make informed financial decisions. You need to know your net income to craft a realistic budget that allows you to cover your family’s necessities, save for future goals, and make other strategic financial moves.

How to use this knowledge in your budget

Here are some practical budgeting tips for parents that incorporate your knowledge of gross and net income:

1. Start with a complete picture: Use your net income to formulate your budget. Knowing how much money you have after deductions helps you allocate funds more effectively.

2. Track your expenses: Keeping a close eye on where your money is going can reveal spending habits and highlight areas for potential savings. Using good budget apps can make tracking easier.

3. Set clear financial goals: Whether you’re saving for a family vacation, a college fund, or your retirement nest egg, having specific goals helps guide your budget and prioritize expenses.

4. Regularly review pay stubs: Whether you receive a paper check or have automatic deposit, spot-check your pay stubs to confirm deductions and net income are accurately reflected – especially if your hours fluctuate or you have multiple income streams.

5. Create an emergency fund: Life can throw unexpected expenses your way, whether it’s a medical issue, car repairs, or a job loss. Build a dedicated emergency fund to help avoid significant debt.

Grasping the primary difference between gross and net income empowers you to make wiser budgeting and future-planning decisions. Stay informed, stay engaged, and make your finances work for your family's future!

This blog post is provided "as is" and should not be relied upon as a substitute for professional advice. Some content in this post may have been created using artificial intelligence; however, every blog post is reviewed by at least two human editors.