How to calculate monthly payroll: a worked example
A monthly-paid employee on the standard tax code 1257L receives £1,047.50 of tax-free pay each month, one twelfth of the £12,570 Personal Allowance [1], and pays National Insurance only on monthly earnings above the Primary Threshold of £1,048 [2]. Those two thresholds, almost identical in cash terms yet governing two separate taxes, are where every monthly payroll calculation begins.
Calculating monthly payroll means turning a gross monthly salary into a net figure the employee receives and a set of amounts the employer owes HMRC. The calculation runs the same way each month: establish gross pay, deduct income tax through the tax code, deduct National Insurance on its own thresholds, apply any student loan and pension deductions, and arrive at net pay. Alongside that sits the employer's own National Insurance and pension cost, which never appears on the payslip but drives the true cost of the role.
This guide works through each deduction in turn, with the 2026-27 thresholds, and then runs a single employee end to end so the arithmetic is visible rather than assumed. It covers income tax on the cumulative basis, employee and employer National Insurance, student loans, workplace pensions, and the final figure the employer pays over to HMRC.
Key takeaways
- Monthly free pay under code 1257L is £1,047.50, and monthly taxable pay above it is taxed at 20%, 40% or 45% depending on the band.
- Employee National Insurance is 8% on monthly earnings between £1,048 and £4,189, then 2% above that.
- Employer National Insurance is 15% on monthly earnings above the £417 Secondary Threshold for the 2026-27 tax year.
- Student loan and pension deductions apply on their own separate thresholds, not the tax or NI ones.
- The employer's true cost is gross pay plus employer National Insurance plus employer pension contributions.
- The amount paid to HMRC each month is the tax, both NI shares and any student loan, due by the 22nd of the following month.
The building blocks of a monthly calculation
A monthly payroll calculation has three inputs before any deduction is worked out: gross pay for the month, the employee's tax code, and their National Insurance category letter [3]. Everything else follows from these. The tax code decides how much income tax is due, the category letter decides which NI rates apply, and gross pay is the base on which both operate.
Gross pay is not just basic salary. It includes overtime, commission, bonuses, and any benefits that are taxed through the payroll, all totalled for the pay period before deductions begin [3]. Before the calculation runs, the employer should confirm the monthly figure still meets the National Minimum Wage or National Living Wage for the hours worked, because minimum-wage compliance is assessed on actual hours and is enforced separately from PAYE [4].
The pay period and the earnings period
For a monthly payroll the pay period is one calendar month, and the same period governs National Insurance and student loan deductions [2]. This alignment matters: the student loan calculation uses exactly the same earnings period as National Insurance, so a monthly-paid worker has their student loan assessed monthly, not annually [5].
Because National Insurance is assessed period by period rather than cumulatively, a one-off bonus in a single month can push earnings into a higher NI band for that month even where annual pay is modest [2]. Income tax behaves differently, smoothing across the year, which is why the two taxes can move in opposite directions in a month with irregular pay. The Moonworkers overview of HMRC-recognised payroll software for SMEs sets out how software keeps the two calculations aligned automatically.
Calculating income tax on a monthly cumulative basis
Income tax is deducted through the tax code, which tells the software how much tax-free pay to give the employee before tax is charged. The standard code for the 2026-27 tax year is 1257L, reflecting the £12,570 Personal Allowance carried forward without an uplift [1]. Divided across twelve months, that gives £1,047.50 of free pay each month.
Taxable pay is monthly gross pay minus the monthly free pay, and it is taxed in bands. The band rates for England and Northern Ireland are set out below, with Scotland and Wales operating their own codes prefixed S and C respectively [6].
| Band | Annual taxable income | Rate |
|---|---|---|
| Basic rate | Up to £50,270 | 20% |
| Higher rate | £50,270 to £125,140 | 40% |
| Additional rate | Above £125,140 | 45% |
How the tax code sets the monthly free pay
The number in a tax code, multiplied by ten, is the annual tax-free allowance, so 1257L means £12,570 [7]. Payroll software spreads that allowance evenly, giving one twelfth to a monthly-paid employee each period, so tax is deducted steadily rather than in a lump at year end [7]. A code beginning with K works in reverse, adding to taxable pay where deductions owed exceed the allowance, and the letters after the number, such as L, M or N, signal which allowance rules apply [8].
On a cumulative code the software looks at total pay and total tax since 6 April, not just the current month, and corrects any under or over-deduction automatically as the year progresses [7]. This self-correcting behaviour is why an employee whose pay varies month to month still ends the year having paid broadly the right tax.
Cumulative versus month 1 basis
Not every code operates cumulatively. An emergency code carrying a W1 or M1 suffix works on a month 1 basis, taxing each month in isolation and ignoring pay and tax earlier in the year [9]. A new starter without a P45 is often placed on this basis until HMRC issues a cumulative code, which usually follows within a pay period or two [9].
The practical effect is that a month 1 calculation gives exactly one month of allowance and one month of each band, with no reference to what came before [9]. When the cumulative code arrives, the next payrun reconciles any difference, which can produce a visibly larger or smaller deduction in the month of the switch [7].
Calculating National Insurance for a monthly payrun
National Insurance runs on entirely separate thresholds from income tax, and unlike tax it is assessed for each pay period on its own, not cumulatively [2]. The category letter assigned to the employee decides which set of rates applies, with category A covering most employees. The monthly thresholds for the 2026-27 tax year are summarised below.
| Threshold | Monthly | Annual |
|---|---|---|
| Secondary Threshold (employer) | £417 | £5,000 |
| Primary Threshold (employee) | £1,048 | £12,570 |
| Upper Earnings Limit | £4,189 | £50,270 |
Employee National Insurance
An employee on category A pays 8% on the slice of monthly earnings between the Primary Threshold of £1,048 and the Upper Earnings Limit of £4,189, and 2% on anything above the Upper Earnings Limit [2]. Earnings below £1,048 in the month attract no employee National Insurance at all. The calculation is applied to that month's earnings only, so it does not smooth across the year the way income tax does [10].
Directors are the exception. Their National Insurance is calculated on an annual earnings period even when they are paid monthly, which prevents a director front-loading a low salary to dodge contributions and often trips up owner-managed companies [11]. A fuller treatment of the employee and employer sides sits in the Moonworkers guide to employer National Insurance.
Employer National Insurance
The employer pays its own National Insurance on top of the employee's, at 15% on monthly earnings above the Secondary Threshold of £417 for the 2026-27 tax year [12]. This is the cost that rose most sharply on 6 April 2026, when the rate moved from 13.8% to 15% and the threshold fell, and it applies from a far lower point than the employee's own contributions begin [12].
Reliefs can reduce this bill. Under-21s and apprentices under 25 attract a 0% employer rate up to £50,270 a year, and eligible businesses can offset part of their employer NI through the Employment Allowance [13]. For a business running several schemes or advising clients, the multi-client view is handled through a payroll bureau platform that applies the right category letter per employee automatically.
Student loan deductions in a monthly calculation
Where an employee is repaying a student loan, the deduction is 9% of monthly earnings above the plan threshold, rounded down to the nearest whole pound [5]. The plan type sets the threshold, and for a Plan 2 borrower the monthly threshold for the 2026-27 tax year is £2,448.75 [14].
The four income-contingent plans carry different thresholds, so the same salary produces a different deduction depending on which plan applies [5]. Where an employee has both an ordinary student loan and a postgraduate loan, the postgraduate loan is deducted first. The annual thresholds are set out below, each divided by twelve for a monthly-paid employee.
| Plan | Annual threshold (2026-27) | Rate |
|---|---|---|
| Plan 1 | £26,900 | 9% |
| Plan 2 | £29,385 | 9% |
| Plan 4 | £33,795 | 9% |
| Postgraduate loan | Separate threshold | 6% |
The mechanics of matching the right plan to an employee are covered in the Moonworkers explainer on student loan deductions through payroll.
Workplace pension contributions
Auto-enrolment adds a pension deduction for eligible workers, calculated on qualifying earnings rather than total pay. Qualifying earnings for the 2026-27 tax year are the slice of pay between £6,240 and £50,270 a year, which works out at £520 to £4,189 a month [15]. The minimum total contribution is 8% of qualifying earnings, of which the employer must pay at least 3% and the employee makes up the remainder [15].
In a common arrangement the employee pays 5% and the employer 3% of qualifying earnings, and only the employee's share is deducted from net or gross pay while the employer's share is an additional cost [16]. The employer must assess each worker for eligibility every pay period, because a pay rise or a birthday can bring someone into scope [16]. The assessment rules are set out in the Moonworkers guide to workplace pension auto-enrolment.
A full worked example, gross to net
Consider a monthly-paid employee on a £42,000 salary, so £3,500 gross a month, on cumulative code 1257L with category A National Insurance, a Plan 2 student loan, and an auto-enrolment pension split 5% employee and 3% employer. Each deduction uses its own threshold.
| Line | Calculation | Amount |
|---|---|---|
| Gross monthly pay | Salary ÷ 12 | £3,500.00 |
| Income tax | (£3,500.00 − £1,047.50) × 20% | £490.50 |
| Employee NI | (£3,500 − £1,048) × 8% | £196.16 |
| Student loan (Plan 2) | (£3,500 − £2,448.75) × 9%, rounded down | £94.00 |
| Employee pension | (£3,500 − £520) × 5% | £149.00 |
| Net pay | Gross minus the four deductions | £2,570.34 |
The employee receives £2,570.34. The employer's own costs sit on top of the gross figure and never appear on the payslip: employer National Insurance of £462.45, being 15% of earnings above £417, and an employer pension contribution of £89.40, being 3% of qualifying earnings [12]. The true monthly cost of employing this person is therefore £4,051.85, not the £3,500 headline salary [15].
What the employer owes HMRC after the calculation
The calculation produces two separate results: what the employee takes home and what the employer pays HMRC. The amount due to HMRC for this employee is the income tax, both National Insurance shares and the student loan deduction, totalling £1,243.11 for the month, made up of £490.50 tax, £196.16 employee NI, £462.45 employer NI and £94.00 student loan [14]. The pension contribution goes to the pension provider, not HMRC.
That figure is reported to HMRC in a Full Payment Submission on or before payday, filed through HMRC-recognised software that carries the badge for Real Time Information [17]. The payment itself is due by the 22nd of the following tax month electronically, or the 19th by post [18]. Platforms that embed payroll rather than run it in a separate application call an HMRC-recognised payroll API that returns these figures and files the submission in one step.
Conclusion
Calculating monthly payroll is a sequence of independent deductions, each on its own threshold: income tax on the tax code, National Insurance on the Primary and Secondary Thresholds, student loans on the plan threshold, and pension on qualifying earnings. Run them in order and the two outputs fall out cleanly, the employee's net pay and the amount owed to HMRC, with the employer's own National Insurance and pension sitting on top as the real cost of the role.
The example shows why the headline salary understates the cost: a £3,500 monthly wage costs the employer £4,051.85 once employer National Insurance and pension are added. As the 15% employer rate settles in and statutory pay reforms continue under the Employment Rights Act 2025, keeping each threshold current is the part most prone to error, and the reason most employers let software apply the rates rather than reconcile them by hand each month.
Frequently asked questions
Why is my employee's National Insurance different from their income tax when they earn the same each month?
Income tax and National Insurance use different thresholds and different methods. Income tax is worked out on a cumulative basis across the whole tax year, smoothing the deduction, while National Insurance is assessed for each month on its own without reference to other months [2]. The two taxes also start at slightly different points, £1,047.50 of free pay for tax against a £1,048 Primary Threshold for NI, so even a steady salary produces two different figures.
How do I calculate a student loan deduction for a monthly-paid employee?
Take the employee's monthly earnings, subtract the monthly threshold for their plan, and multiply the excess by 9%, then round down to the nearest whole pound [5]. For a Plan 2 borrower the monthly threshold for the 2026-27 tax year is £2,448.75 [14]. Where the employee also has a postgraduate loan, that is deducted first and on its own threshold.
Does the employer's National Insurance come out of the employee's pay?
No. Employer National Insurance is an additional cost the employer pays on top of the wage, charged at 15% on monthly earnings above £417 for the 2026-27 tax year [12]. It does not appear on the payslip and does not reduce the employee's net pay. It is one of the reasons the true cost of a role is higher than the salary.
When does the monthly PAYE payment reach HMRC?
The tax, both National Insurance shares and any student loan deducted in the month must be paid to HMRC by the 22nd of the following tax month when paying electronically, or the 19th by post [18]. A tax month runs from the 6th to the 5th. Filing the Full Payment Submission and paying HMRC are separate steps, each with its own deadline.
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