What Are Voluntary Payroll Deductions and How Are They Calculated?

Payroll deductions refer to arrangements in which employers withhold a portion of an employee's paycheck for a specific purpose, typically benefits. They can be involuntary or voluntary payroll deductions.

Medicare and Social Security are typical examples of involuntary payroll deductions that employers are legally required to withhold. In contrast, voluntary payroll deductions are arrangements in which an employee authorizes their employer to withhold a part of their paycheck for a specific purpose, such as healthcare, retirement savings and more.

If you're interested in opting into a voluntary payroll deduction program, you must sign a voluntary payroll deductions form. The form clearly details how much money your employer will subtract from your paycheck and the purpose for which the funds will be used.



Note that your employer is legally required to obtain written consent from you before making any deductions on your pay, with the exemption of FICA taxes. Be sure to read the payroll deduction authorization form carefully before signing the agreement.

First, a Few Abbreviations

Before discussing voluntary payroll deductions, here are a few terms you need to be familiar with to improve your understanding of payroll deductions.

• FICA: It stands for Federal Insurance Contributions Act, a federal payroll tax that funds Medicare and Social Security.
• OASDI: It stands for the Old-Age, Survivors and Disability Insurance, the official name for Social Security. This tax is part of FICA.
• FIT: It stands for Federal Income Tax. The Internal Revenue Service levies this tax on corporate or personal income. FIT is often the most significant deduction on most people's income statements.

Another crucial plan is the Section 125 Plan, which is also called a Cafeteria Plan. This employer-sponsored benefit lets you use your pre-tax income to pay for expenses, such as child care and medical costs. Cafeteria Plans is therefore beneficial as it reduces both the employers' and employees' overall tax burdens.

Why Opt Into a Voluntary Payroll Deduction Plan?

As an employee, you can use payroll deductions as a convenient means of automatically allocating a portion of your income toward an investment or an ongoing expense. For instance, you can have your employer deduct a specific percentage of your income and send it to your traditional or Roth Individual Retirement Account (IRA).

Likewise, you may also choose to have your employer automatically deduct and pay premiums for an insurance policy to ensure you never miss a payment. Sometimes, employees may use voluntary payroll deductions to contribute toward buying shares in common stock.

In these cases, you can opt into your employer's stock purchase plan and have a portion of your paycheck go toward purchasing your employer's stock. You can usually buy the stock at a discounted price.

Here are a few other examples of voluntary payroll deduction plans:

• Contributions to a pre-tax health savings account or flexible spending account
• S. Savings bond purchases
• Vision, dental, medical or health insurance plans
• Employer-sponsored life insurance premiums
• Deductions professional certification fees or tuition
• Payments for purchases of company merchandise such as retired equipment
• Payments for job-specific items, such as tools or clothing
• Contributions toward an employer-sponsored charity
• Retirement savings plan contributions, such as a 401(k) plan or ira
• Union dues
• Short-term disability insurance plans

Common examples of involuntary payroll deduction plans include:

• Court-ordered child support payments
• Wage garnishments
• Local taxes (imposed by towns, counties and cities for unemployment or disability insurance)
• State-mandated income tax withholding
• Federally mandated income tax withholding
• FICA taxes (for Medicare and Social Security premiums and contributions)

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Voluntary Payroll Deductions Reduce Your Overall Tax Burden

Pre-tax deductions apply to an employee's gross income, meaning they're subtracted before taxes and social security. These deductions typically pay for contributions toward life insurance, health insurance, retirement plan or health savings accounts. Moreover, you may be eligible to deduct commuting expenses of up to $260.

These deductions reduce your overall tax burden because they're not taxable, thereby incentivizing employees to participate in the programs. Contributions toward a traditional IRA lower your overall tax burden as they're taken from pre-tax income. In contrast, Roth IRA contributions are taken from your post-tax income, but distributions are not taxable.

How Payroll Deductions Are Calculated

Payroll deductions can be applicable pre- or post-tax. The first step to calculating the take-home pay is to subtract pre-tax deductions, such as retirement contributions and insurance deductions, from the gross salary. The remaining amount is the taxable income.

The next step is to calculate tax withholding that applies to the taxable income. Withholdings include Medicare Social Security and, as well as local, state, federal and taxes.

The final step is to subtract post-tax deductions, including wage garnishments, certain employee expenses, or union dues. After-tax deductions also include Roth IRAs. Once all deductions are made, the resulting amount is the net income you see on your final paycheck.

Payroll Deductions for Tipped Income

Payroll deductions for tipped income are a bit more complicated. You're required to record your tips daily. Furthermore, if your tip earnings exceed $20 in a month, you're required to report the amount via Form 4070: Employee's Report of Tips to Employer. Like employee salaries, combined wages and tips are also subject to payroll deductions and taxes.

Additionally, employers in tipped industries are required to ensure that employee tips are equal to at least 8% of the total revenue that the business earns in the same period. In cases where the tips are not equal to 8% of total revenue, the employer must pay employees the difference. However, Employers may request a lower percentage, as long as it's not than 2%.

Reduce Your Tax Burden and Never Miss a Payment With Voluntary Payroll Deductions

The primary purpose of voluntary payroll deductions is to make contributions toward employee benefits by automatically subtracting specified amounts from an employee's paycheck. Doing so ensures that you don't miss or delay payments such as insurance premiums and retirement savings.

Furthermore, some voluntary payroll deductions are subtracted from your pre-tax income, reducing your overall tax burden. Visit our FAQ page to learn more about payroll and payroll processing questions.

Are you looking for more payroll processing information? Check out our Ultimate Guide to Payroll Processing.

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