What is PAYE? All the info you need

There’s a good chance you’ve come across this acronym before, but what is PAYE, exactly? In this comprehensive guide, we’ll cover all you need to know about PAYE, whether you’re an employee, an employer, a pensioner, or self-employed.

What is PAYE and why am I paying it?

PAYE is one of the two main ways of paying income tax in the UK, the other being Self Assessment. If you’re an employee, an employer, or a pensioner, it’s very likely that PAYE will be part of your working life or retirement.

What does PAYE mean?

PAYE stands for Pay As You Earn. HMRC uses the PAYE system to collect income tax and national insurance contributions. Employers deduct these payments from their employees’ wages and pass the money on to HMRC on their employees’ behalf. Similarly, pension providers take a percentage of pensioners’ incomes and pay this to HMRC on their clients’ behalf. PAYE also helps manage other deductions such as student loans.

The purpose of PAYE

Established in 1944, PAYE is designed to streamline and simplify the process of paying tax. To understand its purpose, it’s helpful to compare it with Self Assessment. This is the other main way of paying tax and is most commonly used by those who are self-employed.

• When tax is paid: With PAYE, tax payments are deducted before they reach people’s bank accounts, which means they don’t have to pay HMRC themselves. With Self Assessment, tax payments are made after people have been paid, so they then need to send HMRC what they owe.
• How often tax is paid: With PAYE, tax is deducted whenever people receive income, i.e. as they earn. For many people, this is through their regular monthly payslip. With Self Assessment, tax is paid back in bigger lump sums once or twice a year.
• How tax is paid: With PAYE, your employer or pension provider arranges tax payments on your behalf. With Self Assessment, you need to complete a tax return yourself or through an accountant, and then pay the amount HMRC charges you.

Who needs to pay PAYE?

While PAYE does apply to a large part of the population, there are certain criteria and exclusions that mean not everyone needs to pay PAYE. Let’s take a look at whether and how PAYE applies to employees, employers, pensioners, and the self-employed.

Employees and PAYE

The vast majority of employees will pay tax via their employer through the PAYE system. The main exception are employees who aren’t earning more than the UK’s tax threshold. This is known as the Personal Allowance, which is the amount of money you’re allowed to earn tax-free. For the tax year 2024–25, the Personal Allowance is £12,570. Anything you earn above this amount is taxed.

Employers and PAYE

Like employees, the vast majority of employers need to use the PAYE system. There are some exceptions, but these are fairly rare:

• Your employees receive less than £123 a week
• Your employees haven’t had other jobs in the current tax year
• Your employees don’t receive expenses or other benefits
• Your employees don’t receive pensions
• Your employees don’t receive Jobseeker’s Allowance, Employment and Support Allowance, or Incapacity Benefit

Unless you meet these criteria in a given tax year, you need to use PAYE.

As an employer, you also need to pay your own National Insurance contributions, which PAYE will calculate for you on top of what your employees owe.

Pensioners and PAYE

There are a couple of different scenarios where those receiving a pension will pay tax on it via PAYE:

• Private pensions: Providers of workplace and personal pensions will operate their own PAYE systems, much the way employers do. So those receiving these types of pensions will have tax deducted by their pension provider before receiving payment.
• State pensions: If you’re receiving your state pension while still in employment, or in addition to other pensions like a personal pension, you’ll pay any tax on it through PAYE. This will be managed by either your employer or pension provider using their PAYE system. If you have more than one pension besides your state pension, only one provider will need to manage your state pension payments.

If your only source of income is your state pension, you can either fill in a Self Assessment form or receive a Simple Assessment tax bill from HMRC.

The self-employed and PAYE

The self-employed are the biggest exception to PAYE. If you’re your own boss, Self Assessment is your primary way of paying income tax. This involves completing a tax return each year, submitting it to HMRC, and paying any tax you owe directly.

But you can sometimes use PAYE if you’re already set up on it elsewhere, for example if you have another job where you’re an employee. To be eligible, you also need to owe less than £3,000 and submit your tax return before a specific deadline. If you don’t meet these criteria, you have to continue paying tax by Self Assessment for your self-employed job and by PAYE elsewhere.

Find out more: Sole trader insurance

How much tax will I pay (PAYE)?

Thankfully, PAYE software calculates the amount each employee, employer, and pensioner owes to HMRC. But it’s still helpful to understand exactly how PAYE is calculated and how much you’ll need to contribute.

PAYE deductions

It’s not just income tax and National Insurance that are deducted on PAYE. It also covers various other deductions, including:

• Student loan repayments
• Pension contributions
• Attachment of earnings orders
• Child maintenance payments
• Payroll giving donations
• Trade union subscriptions

Any deductions that have been applied to your salary will be listed on your paycheck so you can see the exact breakdown.

Calculating PAYE

Earlier in this article, we discussed the Personal Allowance and how tax is calculated on the amount you’re earning above the £12,570 threshold. But this is just the standard amount. If you earn more than £100,000, you’ll receive a smaller Personal Allowance. And if you earn £125,140 or above, you won’t get a Personal Allowance. This information is captured in your tax code, the most common being 1257L.

Deduct your Personal Allowance from your total earnings, and this will give you your taxable income. The amount this taxable income is charged will depend on which tax band you’re in, which in turn depends on how much you earn. The UK tax bands (excluding Scotland) for the 2024–25 tax year are:

• Basic rate: For any income received between £12,571 and £50,270, taxed at a rate of 20%
• Higher rate: For any income received between £50,271 and £125,140, taxed at a rate of 40%
• Additional rate: For any income received above £125,140, taxed at a rate of 45%

For employees (note it’s a bit different for the self-employed), National Insurance contributions are also calculated based on how much you earn. For the current tax year, these are:

• £1,048 to £4,189 a month: 8%
• More than £4,189 a month: 2%

You’ll need to calculate any other deductions according to your personal circumstances. For example, they’ll vary depending on your student loan plan or the pension contribution level you’ve set.

What are the PAYE responsibilities of employers?

If you’re an employer, it’s your job to ensure your payroll is being run correctly. While many employers choose to outsource PAYE to third-party providers, legal responsibility still sits with the employers themselves.

For employers who choose to manage PAYE rather than outsource it, there are a few key responsibilities to be aware of. You have to:

• Register for PAYE with HMRC.
• Let HMRC know what employee payments and deductions you’re making on or before payday (this is called a Full Payment Submission).
• Let HMRC know about any reductions you and your employees are entitled to, e.g. for statutory pay such as maternity or sick pay (this is called an Employer Payment Summary).
• Keep HMRC updated on your employees, e.g. if you hire someone new or if the circumstances of an existing employee change.
• Pay HMRC by the 22nd of each month, or by the 19th if you pay by post (or quarterly if you’re a small business that owes less than £1,500 each month). Be aware that missed payment deadlines can lead to interest and fines.
• Send HMRC reports at the end of each tax year.
• Retain your tax records for at least three years after the end of each tax year.

Read more: Limited company insurance

How to handle common challenges with PAYE

While PAYE is designed to make the taxation process easier, it’s still quite a complex system. It can feel daunting, especially at first or if something goes wrong. Here we cover how to deal with some of the most frequent problems.

• Checking payments: With your tax payments handled by others before they even reach your pocket, it can be hard to feel sure you’re paying the right amount. But there are a few ways to check this, including your payslip and your annual P60. These should include things like your tax code and a breakdown of your payments so you can check the amounts yourself.
• Overpaying or underpaying tax: If you’ve overpaid or underpaid tax, HMRC will let you know at the end of the tax year using what’s known as a P800 notice. If you’ve overpaid tax, you can use this form to claim a refund. If you’ve underpaid tax by up to £3,000, HMRC will adjust your tax code and Personal Allowance for the next year to make up for the shortfall. If you’ve underpaid by more than that, HMRC will bill you for a direct payment. But if you underpaid due to a delay or a mistake by HMRC, you can request a write-off.
• Running PAYE: Probably the biggest challenge for employers is running PAYE. One option is to pay a third-party provider to manage PAYE on your behalf. You can also outsource things like creating paychecks to them as well. The other option is to get PAYE software that supports you with calculations, admin, and reporting.

Quickfire summary

PAYE (Pay As You Earn) is the main way that employees, employers, pensioners, and pension providers pay income tax and national insurance to HMRC. Some exceptions to PAYE include people who are self-employed and those whose only income is the state pension. It calculates various deductions on people’s incomes, so before the money reaches their accounts.

Also read:

• All You Need to Know About the PAYE Reference Number
• Everything You Need to Know About Your P45 vs P60
• What is your ERN?

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