Read this article to learn about different types of payroll deductions, common mistakes in calculating them and how to streamline deductions management.
If you are looking to automate payroll deductions, Finch can help. Talk to sales.
Payroll deductions refer to the money withheld from an employee's paycheck each pay period to cover taxes, benefit premiums, and other financial obligations. Whether you're a business establishing your payroll, a SaaS tool offering employee benefits, or an employee seeking clarity on paycheck adjustments, it's crucial to grasp the different types of payroll deductions and how they differ.
This article explores common payroll deductions, their legal requirements and addresses some frequently asked questions. Plus, for those involved in employee benefits, retirement, health insurance, and more, we have a bonus section that explains how to seamlessly adjust deductions within the employer's payroll system.
Now, let’s decode different types of payroll deductions one by one.
Payroll deductions involve subtracting money from an employee's total wages each pay cycle to cover both mandatory and voluntary employment expenses, including taxes, benefits, and garnishments.
Each deduction has distinct calculations, regulatory requirements, and is applicable in different scenarios.
The deduction amount depends on multiple factors like federal or state tax laws, withholding information supplied by the employee in their Form W4: Employee’s Withholding Certificate, and the benefits programs the employee is subscribed to. The calculation process can be manual or automated.
Some types of benefits deductions are taken out of a paycheck based on the written approval of the employee. However, statutory deductions and garnishments are withheld by the employer as mandated by law.
Here are the common payroll deductions to keep in mind if you are working for an employee benefits or payroll company that does business in the United States.
Mandatory deductions are commonly called withholdings. Some examples of statutory payroll deductions include state and federal taxes, wage garnishments, and FICA.
Employees can choose from various employer-offered benefits programs and agree to deductions from their paychecks on either a pre-tax or post-tax basis. These programs encompass 401(k) and retirement plans, health insurance, health savings accounts (HSA) and flexible spending accounts (FSA), life and disability insurance, commuter benefits, wellness programs, college savings plans, and other common voluntary payroll deductions.
Note: Employers need written authorization from the employee for the following deductions:
Voluntary and mandatory payroll deductions can be further classified as pre and post-tax deductions.
Pre-tax deductions are subtracted from an employee's gross paycheck before any state or federal taxes are withheld, lowering the taxable income. Common examples include health insurance, commuter benefits, group term life insurance, health savings accounts (HSA), flexible spending accounts (FSA), and retirement benefits plans. While participation is optional, it is generally beneficial for employees. Note that there's an annual limit set by the IRS on how much can be contributed to these pre-tax plans, such as 401(k).
Conversely, post-tax payroll deductions are adjusted from an employee's paycheck after taxes have been withheld. Examples include Roth IRA retirement contributions, charitable donations, disability insurance, and garnishments. These deductions don't reduce an employee's tax burden. Employees can choose not to contribute to these plans, except for wage garnishments.
Employers typically rely on benefits partners to inform them about various deduction details. These deductions are then processed through a payroll provider to determine an employee's net take-home pay. Payroll providers also ensure that necessary payments are made to the appropriate government entities on time.
The payroll deduction process follows a standard sequence:
As you can see, to successfully manage payroll deductions, there’s a lot of information exchange required between the employer, payroll provider, and benefits plan partners. Manual processes can render this experience even more redundant and error-prone. Tools like Finch help automate payroll deductions to ensure a seamless experience end-to-end. Learn more.
With so many deduction types, mistakes can happen. Common errors include:
Automating payroll deductions is highly beneficial as it captures changes and updates employee information, employment status, and contribution details promptly between systems, reducing errors in deduction calculations. Learn how Finch's automated deductions can reduce deduction errors altogether.
If payroll is calculated with incorrect deduction details it can result in employees being enrolled into the wrong tax brackets. This can result in higher taxes, penalties, or lost interest for employees.
If withholding calculations are not compliant with state and federal laws, employers need to compensate for back payments, not the employees.
Core benefits are the primary benefits employees receive for being employed by an organization. This includes retirement benefits, health insurance, etc. Fringe benefits are the extra perks that some employees get like free meals, childcare (up to $5,000), gym memberships, mental health benefits, group term life insurance, employee discounts, etc.
While most core benefits are mandated by federal and tax laws, employers offer fringe benefits to retain talent and infuse a positive work culture. The fringe benefits that are translated into cash form are usually deducted from employee wages.
Finch is committed to making payroll deductions easy and automated for employers. It aims to do this by helping innovative SaaS tools in the retirement, benefits, and insurance sectors build solutions that can be integrated with 200+ HR and payroll systems using a single unified employment API. By allowing benefits providers to fetch data from the employer’s source of truth, Finch ensures data accuracy and timely contribution updates to payroll.
Streamline deductions management: Finch eliminates the need for flat files, SFTP, or manual data entry to fetch employee census data and contribution details. It automates the entire process of payroll deductions by connecting the employer’s payroll systems with the benefit providers' tool.
Enhance accuracy through automation: Today, every employer is looking for automated deductions management. It frees up employer admin time as they don’t have to manually enter data into the provider’s system each time employment status changes.
Similarly, all contribution details can be written back into the payroll system without manual intervention. Automated adjustments increase data accuracy and help employers avoid the common payroll deduction mistakes we discussed earlier.
If you are a SaaS tool looking to automate payroll deductions, reach out to us, we’d be happy to help.