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1.8 E) Gross Pay, Net Pay, Taxes & Pension Contributions – Part 1
1.8 E) Gross Pay, Net Pay, Taxes & Pension Contributions – Part 1
Gross pay refers to the amount of money that an individual is paid before any deductions are made. The deductions could be tax, national insurance, student loan repayments or pension contributions.
Net pay is the amount of money that the worker gets after all of the deductions have been taken off the workers gross pay. Sometimes net pay is referred to as “take home pay”.
Net pay is the amount of money that the worker gets after all of the deductions have been taken off the workers gross pay. Sometimes net pay is referred to as “take home pay”.
Deductions
There are many different types of deductions and most of these deductions are a percentage of gross pay. For example, income tax, national insurance, student loan repayment and (usually) pension contributions are all percentage based.
There are many different types of deductions and most of these deductions are a percentage of gross pay. For example, income tax, national insurance, student loan repayment and (usually) pension contributions are all percentage based.
Example 1
An individual has a monthly gross pay of £2,400. They pay 20% tax on these earnings and £150 for pension contributions. How much is her net pay? You may use a calculator.
There are two different ways to answer this question.
Method 1
The first method is to find the amount of tax that is paid and then take the tax and the pension contribution off the gross pay.
An individual has a monthly gross pay of £2,400. They pay 20% tax on these earnings and £150 for pension contributions. How much is her net pay? You may use a calculator.
There are two different ways to answer this question.
Method 1
The first method is to find the amount of tax that is paid and then take the tax and the pension contribution off the gross pay.
We are given the pension contribution in the question, but we are not given the amount of tax. However, we are told the percentage tax, which is 20%. Whenever we are working out percentages of something with a calculator, it is easier to use multipliers. We obtain multipliers by dividing the percentage by 100. Therefore, 20% as a multiplier is 0.2. To find the amount of tax that is paid, we multiply the gross pay by the multiplier.
We are now able to sub the respective values into the net pay formula.
Therefore, the net pay for our individual is £1,770.
Method 2
The second method is to find the amount after tax in one step. Our individual is paying a tax rate of 20%. This means that she gets to keep 80% of her gross pay (100% – 20% = 80%). 80% as a multiplier is 0.8 (80% ÷ 100 = 0.8). Therefore, the amount of money that our individual receives after tax is found by using the working below.
Method 2
The second method is to find the amount after tax in one step. Our individual is paying a tax rate of 20%. This means that she gets to keep 80% of her gross pay (100% – 20% = 80%). 80% as a multiplier is 0.8 (80% ÷ 100 = 0.8). Therefore, the amount of money that our individual receives after tax is found by using the working below.
The next step is to take her pension contributions off.
This method gives us the same net pay as before.
Example 2
Sometimes we will be asked questions whereby there is a variable tax rate meaning that the tax rate varies as income rises. The question below is an example of one of those questions.
I earn £4,000 per month. I pay 10% tax on the first £1,000 of my earnings. I pay 25% tax on any earnings between £1,000 and £3,000. I then pay 45% tax on any earnings above £3,000. How much tax do I pay?
It is sometimes best to draw a number line to answer questions like this. We will then split the number line up into different tax rates. The number line needs to run from £0 to the amount that I earn, which is £4,000.
Sometimes we will be asked questions whereby there is a variable tax rate meaning that the tax rate varies as income rises. The question below is an example of one of those questions.
I earn £4,000 per month. I pay 10% tax on the first £1,000 of my earnings. I pay 25% tax on any earnings between £1,000 and £3,000. I then pay 45% tax on any earnings above £3,000. How much tax do I pay?
It is sometimes best to draw a number line to answer questions like this. We will then split the number line up into different tax rates. The number line needs to run from £0 to the amount that I earn, which is £4,000.
From the question, we are told that there are 3 different tax rates. The first tax rate is 10% on the first £1,000. We are able to find out how much tax I pay on this £1,000 by multiplying the multiplier for 10% (0.1) by £1,000; I pay £100 tax for this tax bracket.
We now move onto the next tax rate, which is a tax rate of 25% on earnings between £1,000 and £3,000. I earn £4,000, which means that £2,000 of my earnings is in this tax rate. I am able to find out what 25% of £2,000 is by multiplying 0.25 (the multiplier for 25%) by £2,000. This calculation tells me that I pay £500 tax for this tax bracket.
We are now onto the final tax rate, which is the 45% tax on earnings above £3,000. I earn £4,000, which means that I have £1,000 of earnings that I have to pay 45% tax on. We find out what 45% of £1,000 is by multiplying 0.45 (the multiplier for 45%) by £1,000. This calculation tells me that I pay £450 tax for this tax bracket.
The final step is to add all of tax amounts from the different tax brackets.
Therefore, the amount of tax that I pay is £1,050.