💷 PAYE: How It Works

What is PAYE?

Pay As You Earn (PAYE) is HMRC's system for collecting Income Tax and National Insurance from employees. Instead of you paying a lump sum at the end of the year, your employer deducts tax from each pay packet throughout the year.

It's automatic — you don't need to do anything unless your tax code is wrong or you have additional income to declare.

How the Calculation Works

Each pay day, your employer's payroll software:

1. Takes your gross pay for the period
2. Applies your tax code to work out your tax-free amount
3. Calculates Income Tax on the taxable portion using the correct bands
4. Calculates employee National Insurance contributions
5. Deducts any student loan repayments
6. Deducts any pension contributions
7. Pays you the remainder — your take-home pay

Cumulative vs Non-Cumulative

Most PAYE operates on a cumulative basis. This means your employer keeps a running total of your pay and tax for the year. If you earn less in one month, you might get a refund in your next pay packet because the cumulative calculation shows you've been overtaxed.

Non-cumulative (W1/M1) codes calculate tax only on that period's earnings, ignoring what happened before. This is less accurate but used as a temporary measure.

Understanding Your Payslip

National Insurance Through PAYE

Employee NI (Class 1) is collected alongside Income Tax:

• 8% on earnings between £12,570 and £50,270 per year
• 2% on earnings above £50,270

Unlike Income Tax, NI is calculated per pay period (not cumulatively). If you have a particularly high month, you might pay more NI than expected — but you can't get it back later in the year.

When Do You Need Self Assessment?

Even if you're on PAYE, you may still need to file a Self Assessment tax return if:

• Your income exceeds £150,000 (from April 2023: £100,000)
• You have self-employment income over £1,000
• You have rental income
• You receive dividends above the £500 allowance
• You have capital gains to report
• You need to claim tax relief on pension contributions (higher rate)
• You need to claim Gift Aid tax relief
• You have foreign income

P45 and P60

P45

When you leave a job, your employer gives you a P45. It shows your total pay and tax for the year so far. Give it to your new employer so they use the correct tax code from day one. Without it, you'll be put on an emergency code.

P60

At the end of each tax year (after 5 April), your employer gives you a P60 summarising your total pay and tax for the year. Keep this — you'll need it for mortgage applications, tax returns, and checking HMRC's records.

Tax Refunds Through PAYE

If you've overpaid tax (perhaps due to a wrong code or uneven earnings), HMRC should automatically refund you — either through an adjusted pay packet or as a direct payment. If they don't, you can claim via your Personal Tax Account or by calling HMRC.