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From 6 January 2024, the main rate of class 1 National Insurance contributions (NIC) deducted from employees’ wages is reduced from 12% to 10%. From 6 April 2024, the main rate of self-employed class 4 NIC will reduce from 9% to 8% and class 2 NIC will no longer be due. Those with profits below £6,725 a year can continue to pay class 2 NIC to keep their entitlement to certain state benefits. Our guidance will be updated in full in spring 2024.

Updated on 6 April 2023

Pay As You Earn (PAYE)

The Pay As You Earn (PAYE) system is a method of paying income tax on certain types of income. If you pay tax under PAYE on some of your income, tax is deducted at source on that income. This means you receive it net of tax.

Content on this page:

Introduction

The PAYE system is a method of paying income tax on employment income and pension income. The PAYE system is very important when working out your overall tax position, so you need to be able to understand it. You need to be able to work out your tax, so that you can check your employer is deducting the right amount of tax from your pay or so that you can check your pension provider is deducting the right amount of tax from your pension.

Employment income

If you are an employee, your employer takes income tax and National Insurance contributions (NIC) off your pay before paying you. Your employer sends the tax and NIC to HM Revenue & Customs (HMRC). On top of your own tax and NIC, your employer may pay extra employers’ NIC to HMRC.

Employers in the UK must operate PAYE under the law if they have at least one employee whom they pay more than a certain amount of money (£123 per week in 2023/24).

Your employer should operate PAYE on all cash earnings, such as salary, overtime and bonuses.

As well as being taxed on your cash pay, you are also taxed on most benefits that your employer provides, such as medical insurance. However, PAYE may not be applied by your employer to such benefits. You may need to pay tax on them directly to HMRC at the end of the year – or you can ask for that tax to be included in your tax code – see below. Alternatively, they may be taxed by adding a notional amount to your taxable pay.

Pension income

If you are receiving pension income, your pension provider takes income tax off your pension income before paying it to you. Your pension provider sends the tax to HMRC. This applies to occupational pensions, private pensions and retirement annuities. Note, however, that the Department for Work and Pensions (DWP) does not deduct income tax from the state pension under PAYE.

How it works

PAYE spreads your tax (and NIC) over the tax year – this means you pay your tax (and NIC) whenever you receive a payment of employment or pension income, rather than having to pay your income tax (and NIC) in one lump sum.

There are three parties involved in the PAYE process – HMRC, your employer or pension provider, and you.

HMRC do the following:

  • calculate a tax code for you based on the information they have about you – this is your PAYE code and will include any tax-free personal allowance that is available to you,
  • send you a PAYE coding notice (a form P2), if they are required to do so, showing you how they have worked out your tax code, and
  • tell your employer or pension provider what your tax code is, but not how they have worked it out.

Your employer or pension provider uses that tax code to work out how much tax to take off your weekly or monthly pay or money you get from your pension. They regularly pay over that tax, and NIC if appropriate, to HMRC.

There are some cases where HMRC are not obliged to issue a paper PAYE coding notice to you, but you can still ask them for one. You can see your current coding notice in your personal tax account. Or if you fill in a tax return each year and are registered for self assessment online, you should be able to view your PAYE coding notices online.

As part of the PAYE system, if you are an employee, each pay day your employer should give you a payslip setting out your pay and tax. Your payslip should show the PAYE code that your employer is using. At the end of the tax year, your employer or pension provider should give you a form P60 which sets out the total amounts paid to you and deducted from you for the previous tax year.

The tax collected under PAYE is an estimate and is not necessarily the exact amount you are required to pay. However, for many employees and pensioners there will be little or no difference between the amount of tax deducted under PAYE and the amount of tax actually due on their employment or pension income. See the example Paul below and our page PAYE at the end of the tax year.

Money from pensions may be taken flexibly, perhaps in regular or irregular lump sums (or the full amount as a lump sum). In this situation, the PAYE system may use an emergency code and you may not pay the right tax at the right time. Read our page How tax is collected on flexible pension payments for more information.

PAYE is normally worked out on a cumulative (ongoing) basis. A cumulative tax code can mean that your employer might sometimes pay you a tax refund through the payroll. See the example Emily below.

Note that a PAYE code cannot usually collect more than 50% of your gross wages or pension. This is to prevent hardship for an employee or pensioner. It is most usual to see this limit applying where large tax debts are being coded out. If HMRC cannot collect debts via PAYE, they may ask you to file a self assessment tax return.

Things to check

Although the PAYE system sounds quite simple, it does not always result in you paying the correct amount of tax. So it is very important that you check:

  • your PAYE coding notice;
  • that HMRC have used information about you correctly in working out your tax code; and
  • that your employer or pension provider is using the correct tax code for you.

If you do not understand your PAYE code or think it might be wrong, you should query it with HMRC. You can find their contact details on GOV.UK. HMRC also have a tool that can be used to check what your tax code means.

It is possible for you to pay too much tax under PAYE. You can find out more about PAYE refunds, including how to claim them, on our page PAYE tax refunds.

Please note that under PAYE, you are unlikely to pay the wrong amount of NIC. See our page National Insurance for more information.

Examples

Paul: PAYE reconciliation

Paul earns £20,000 per year, paid monthly (so £1,667 per month). His tax code is 1257L. This is Paul’s only income.

Under this tax code, Paul’s employer knows that Paul will be entitled to £12,570 of tax-free income a year (his personal allowance) or £1,048 per month. Each month, tax is calculated on £619 at 20% (that is, his £1,667 salary less £1,048). This gives £123.80 per month PAYE tax, or £1,485.60 at the end of the year.

At the end of the year when Paul wants to work out his tax, he can see the PAYE deducted from him is roughly correct:

Salary £20,000
Less: personal allowance (£12,570)
Taxable income £7,430
Income tax (£7,430 x 20%) £1,486
Tax already deducted under PAYE £1,485.60

Paul’s income tax position is balanced – there is no more tax to pay and nothing due back to him.

Emily: cumulative PAYE code

Emily works for a single employer in England, but her earnings vary each month depending on how much overtime she works. She is not entitled to any special allowances and has no benefits or expenses relating to her job, so her PAYE code gives her only the basic personal allowance of £12,570 for 2023/24. This makes her code 1257L, which her employer uses on a cumulative basis.

So, each month from the start of the tax year on 6 April, Emily is allocated one-twelfth of her personal allowance.

April

She starts off in April with £1,048 of allowances (£12,570 divided by 12). She earns only £978 in this month, so she pays no tax and has £70 of personal allowance spare – this can be used against wages in future periods.

May

In May, she gets another £1,048 of allowances, so she can earn £1,118 in May without paying tax. Once again she earns only £978, so she then has £140 of personal allowance spare to use against June's pay.

June

By adding that £140 left over from May to June’s £1,048 allowance, she can earn £1,188 this month without paying tax.

Emily works extra hours in June, earning £1,268. She only has £1,188 of personal allowance, so she has to pay tax on £80. The tax rate is 20% so her employer deducts £16 tax (£80 x 20%).

July

In July, she works fewer hours, only earning £878, but because she gets another £1,048 of personal allowance, she has £170 spare. Because Emily is on a cumulative tax code, the extra £80 that was taxed in June can now use up some of those spare July personal allowance. Her employer gives her back the £16 she paid last month as a tax refund. She is then left with £90 (£170 - £80) of spare allowance from July to add to August’s £1,048 personal allowance.

And so it goes on throughout the year.

More information

If you would like information on how tax works if you have more than one job, see our page Multiple jobs.

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