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Almost everyone who has had a job in the UK has seen PAYE and National Insurance on a payslip. Far fewer people, including some who are starting out in payroll roles themselves, could actually explain what is happening behind those two deductions, why they are separate, or what an employer is legally required to do with them each time they run payroll.
This guide breaks both down properly: what PAYE actually is, how the income tax bands work, how National Insurance is calculated and why it exists separately from income tax, what a tax code is really telling you, and what an employer has to report to HMRC every time they pay their staff.
What PAYE actually is
PAYE stands for Pay As You Earn, and it is the system HMRC uses to collect income tax and National Insurance from employees at source, rather than asking every employee to calculate and pay their own tax directly. Your employer works out how much tax and National Insurance you owe on each payment, deducts it before your wages reach your bank account, and pays it to HMRC on your behalf.
This is why PAYE is fundamentally an employer responsibility rather than an employee one. If a payroll calculation is wrong, whether that is an incorrect tax code, a missed National Insurance category change, or a late submission, it is the employer who is on the hook with HMRC, not the individual employee sitting at their desk unaware anything has gone wrong.
How PAYE income tax actually works
Income tax in England, Wales and Northern Ireland is charged in bands, and understanding the bands is the key to understanding almost everything else about how a payslip is calculated. Everyone gets a tax-free Personal Allowance, currently £12,570 a year, on which no income tax is charged at all. Above that, income between £12,571 and £50,270 is taxed at the basic rate of 20%. Income between £50,271 and £125,140 is taxed at the higher rate of 40%. Anything above £125,140 is taxed at the additional rate of 45%.
There is a detail in that structure that catches a lot of people out once they start earning above £100,000: the Personal Allowance itself starts shrinking once income passes £100,000, reducing by £1 for every £2 earned above that point, until it disappears completely at £125,140. Because that tapering happens on top of the standard 40% higher rate, it creates an effective marginal tax rate of 60% on income within that band, even though no single tax rate of 60% technically exists. It is a genuinely useful thing to understand in payroll, because it explains why some employees’ take-home pay behaves in ways that look confusing if you only look at the headline tax bands.
Scotland runs its own income tax bands, set by the Scottish Parliament rather than Westminster, with seven separate bands ranging from a starter rate of 19% up to a top rate of 48%. Scottish employees are identified in payroll by a tax code beginning with the letter S, and it is a genuinely common beginner mistake to apply the standard rUK bands to a Scottish employee simply because the rest of the calculation looks familiar.
How National Insurance works, and why it is separate from income tax
National Insurance is calculated and deducted alongside income tax, but it is a genuinely different system with a different purpose. Where income tax generally funds public spending as a whole, National Insurance contributions are what build an individual’s entitlement to certain state benefits, most importantly the State Pension, along with contributing to statutory payments like Maternity Allowance for people who do not qualify through an employer scheme.
For most employees, National Insurance is charged as Class 1 contributions. The employee pays a percentage of their earnings above the primary threshold, currently £12,570 a year, matching the income tax Personal Allowance, at a rate of 8% up to the Upper Earnings Limit of £50,270, and 2% on anything earned above that.
Employers pay National Insurance too, and this is where a lot of payroll beginners get caught out, because it is easy to assume National Insurance is purely an employee deduction. It is not. Employers pay their own separate National Insurance contribution on top of an employee’s wages, calculated once earnings pass the secondary threshold, currently £5,000 a year, at a rate of 15%. This employer contribution does not come out of the employee’s pay at all. It is an additional cost the employer carries directly, which is one of the reasons National Insurance changes tend to generate so much attention from business owners specifically, since a rate change directly affects the cost of employing someone, not just the employee’s take-home pay.
Smaller employers get some relief from this through the Employment Allowance, which currently allows eligible businesses to reduce their employer National Insurance bill by up to £10,500 a year, a detail that genuinely matters for small business payroll and is worth knowing even at beginner level.
What a tax code is actually telling you
A tax code looks like a random string of numbers and a letter, but it is actually a fairly precise instruction to the employer’s payroll software about how much tax-free income that specific employee should get before PAYE starts deducting tax. The standard code for most people with one job and the full Personal Allowance is 1257L, where the number represents the tax-free allowance divided by ten, and the L simply confirms the employee is entitled to the standard Personal Allowance.
Other letters change the calculation. A BR code means all income from that job is taxed at the basic rate with no tax-free allowance applied at all, which typically happens with a second job or pension. A D0 code applies the higher rate to all income from that source, and a K code, unusually, indicates negative tax-free allowance, meaning extra tax is added rather than allowance deducted, which usually happens when an employee has taxable benefits, like a company car, that outweigh their allowance. Emergency tax codes get applied when an employer does not yet have full information about a new employee’s tax history, and they are a genuinely common source of payroll queries in the first few weeks of someone starting a new job, because they can result in someone being taxed more than they should be until HMRC issues the correct code.
Real Time Information: what employers actually have to report
Since PAYE moved to Real Time Information, usually shortened to RTI, employers have to report pay and deductions to HMRC on or before the date they actually pay their employees, not at the end of the month or the end of the tax year. Every payroll run generates a Full Payment Submission, telling HMRC exactly what was paid and what was deducted for every employee, and if a business needs to report a change without an accompanying payment, such as an employee leaving, an Employer Payment Summary covers that separately.
This is one of the areas where the theory of payroll and the practical, software-driven reality genuinely diverge, because in practice this reporting happens automatically through payroll software like Sage Payroll or QuickBooks Payroll each time a payroll run is processed, rather than being something a payroll administrator calculates and submits by hand. Understanding why the report exists and what HMRC does with it, though, is exactly the kind of foundational knowledge that separates someone who can competently run payroll from someone who is just clicking through software without understanding what it is actually doing.
Statutory payments, briefly
Beyond the standard tax and National Insurance calculation, payroll also has to account for a set of statutory payments that employees may be entitled to at different points: Statutory Sick Pay for employees off work due to illness, Statutory Maternity Pay and Statutory Paternity Pay around the birth of a child, and Statutory Adoption Pay for employees adopting a child. Each has its own eligibility rules and rates, and calculating them correctly, on top of the standard PAYE and National Insurance deductions, is one of the more detailed skills a payroll professional needs to build.
P45s, P60s and P11Ds
Employees encounter a handful of standard payroll documents over the course of employment. A P45 is issued when someone leaves a job, showing their pay and tax details for that employment, and it is what a new employer uses to set up the correct tax code when someone starts a new role partway through the tax year. A P60 is issued to every employee still in post at the end of the tax year, summarising their total pay and deductions for that year, and it is a document employees regularly need for things like mortgage applications. A P11D reports certain benefits and expenses provided outside of normal payroll, such as a company car or private medical insurance, and it has its own separate reporting deadline to HMRC.
Common mistakes payroll beginners make
A handful of errors come up repeatedly with people new to payroll. Carrying over an old tax code without checking it against a new starter’s P45 or starter checklist is one of the most common, and it can result in an employee being taxed incorrectly for weeks before anyone notices. Applying the wrong National Insurance category, particularly for employees under 21, apprentices, or those over State Pension age, who are subject to different rules, is another. Missing an RTI submission deadline, even by a day, can also trigger penalties for the employer, which is exactly why understanding the underlying logic of the system, not just which buttons to click in the software, matters so much in this role.
Common questions about PAYE and National Insurance
Why are PAYE and National Insurance shown as separate deductions if they are both taken by the employer at the same time? Because they fund different things and are calculated on different rules. Income tax under PAYE contributes to general government spending, while National Insurance specifically builds an individual’s entitlement to the State Pension and certain benefits. They happen to be deducted together for administrative convenience, but they are legally and functionally separate systems, with separate thresholds and separate rates.
Does every employee pay National Insurance? No. Employees earning below the primary threshold, currently £12,570 a year, do not pay employee National Insurance, even though their employer may still owe employer National Insurance once combined staff costs pass the relevant limits. Certain groups, including some apprentices under 25 and employees under 21, are also subject to different National Insurance categories with different rates, which is exactly the kind of detail that trips up people new to running payroll.
What happens if an employee has more than one job? Only one job can normally use the standard tax code with the full Personal Allowance applied. Any additional job is usually taxed under a BR code, with no tax-free allowance applied to that income, on the assumption the allowance is already being used against the main job. It generally balances out correctly across the tax year, but it is a common source of employee queries when a second payslip looks like it is being taxed unfairly.
Is running payroll something a small business owner can realistically do themselves? For a very small number of employees, yes, provided they use proper payroll software that handles RTI reporting automatically rather than trying to calculate deductions by hand. Once a business has more than a handful of staff, varying tax codes, statutory payments and National Insurance categories to manage, most owners find it is worth either training someone internally or bringing in dedicated payroll support, simply because the cost of getting it wrong, in penalties and in staff trust, outweighs the cost of doing it properly.
Where this fits into a payroll career
Payroll is one of those functions every employer needs, which makes it a genuinely stable and transferable career. Payroll Administrator roles typically start in the region of £25,000 to £35,000, with more experienced Payroll Specialist roles reaching £40,000 or more, and an average entry salary into the field currently sitting at around £35,000. It is also a role that suits people already partway through AAT, ACA, ACCA or CIMA study, since payroll knowledge is a genuinely useful, practical complement to broader accounting qualifications rather than a separate track entirely.
Getting started
Understanding PAYE and National Insurance at the level covered in this guide is a solid foundation, but running payroll competently and confidently, calculating statutory payments correctly, submitting RTI reports on time, using the same software real employers rely on, is a hands-on skill that is genuinely difficult to build from reading alone.
Our Advanced Payroll Training course covers exactly this: 40 hours of practical, hands-on training in Sage Payroll and QuickBooks Payroll, covering payslips, P45s and P60s, tax and National Insurance calculations, statutory payments, RTI reporting, tax code allocation, employee loans and final payroll runs, delivered through flexible 1-to-1 training and mentorship, with a CPD-approved certification on completion and guaranteed recruitment support to help you turn the qualification into an actual job.
To speak to the team about the course, call 020 3038 8548 or email enquiries@pctrainings.co.uk.
