Did you know that over 30 million UK workers pay tax through the PAYE for employees system each year? Yet many struggle to fully understand how their tax is calculated or what their payslip actually means.
PAYE (Pay As You Earn) remains the primary method HMRC uses to collect income tax and National Insurance contributions directly from your wages. However, according to recent surveys, nearly 40% of British workers cannot correctly explain how their tax deductions work. This knowledge gap often leads to overlooked errors or missed opportunities to manage your finances effectively.
This step-by-step guide will walk you through everything you need to know about the PAYE system in 2025. From understanding tax codes to checking your payslip for accuracy, you'll gain the confidence to take control of your tax affairs. Whether you're starting your first job or simply want to ensure you're not overpaying, this straightforward approach will help you master PAYE without the confusion.
Let's break down the PAYE system into manageable steps so you can better understand where your money goes each month.
Step 1: Understand What PAYE Means for You
The PAYE system forms the backbone of tax collection in the UK, affecting millions of employees. Understanding how it works puts you in control of your finances and helps you spot potential discrepancies in your pay.
What PAYE stands for and why it exists
PAYE stands for Pay As You Earn, a system designed by HMRC to collect Income Tax and National Insurance contributions directly from your wages before you receive them [1]. Rather than facing a substantial tax bill at the end of the year, PAYE spreads your tax payments evenly throughout the tax year [2].
Essentially, your employer acts as an intermediary between you and HMRC. They calculate the correct deductions, take them from your salary, and pass them on to the tax authorities [2]. This arrangement benefits both parties—HMRC receives regular tax income, while you avoid the stress of saving for a large annual tax payment.
The system was created to simplify tax compliance for employees. Without PAYE, you would need to calculate and submit your own tax payments, which could lead to budgeting difficulties and potential errors. Furthermore, the system helps ensure consistent government revenue throughout the year rather than in unpredictable lump sums.
How PAYE affects your take-home pay
Your take-home pay—the amount that actually reaches your bank account—is directly impacted by PAYE deductions [3]. When your employer processes payroll, they subtract:
- Income Tax (based on your earnings and tax code)
- National Insurance contributions (if you earn above the threshold)
- Student loan repayments (if applicable)
- Pension contributions (if you're enrolled in a workplace scheme)
For instance, if your monthly salary is £2,500, and after calculations your employer deducts £400 in Income Tax and £200 in National Insurance, your take-home pay would be £1,900 (minus any other deductions like pension contributions) [4].
Each of these deductions should appear separately on your payslip, providing transparency about where your money goes [5]. Your tax code plays a pivotal role in determining how much tax is deducted—it tells your employer how much tax-free income you're entitled to during the tax year [6].
Who needs to be on PAYE
Nearly all employees in the UK earning above the tax threshold must be registered under the PAYE system [2]. Specifically, your employer must register you for PAYE if any of these conditions apply:
- You earn £96 or more per week (£417 per month) [1][4]
- You receive expenses or company benefits
- You're receiving a pension
- You've held another job during the current tax year
- You've received certain benefits such as Jobseeker's Allowance [1]
The PAYE system additionally applies to occupational pension recipients [7]. Even if you earn below the personal allowance (currently £12,570 per year), your employer might still need to operate PAYE for you, though they won't deduct Income Tax unless you exceed this threshold [4].
For National Insurance specifically, if you earn more than £1,048 monthly (£242 weekly), your employer must deduct National Insurance contributions from your wages [4]. Nonetheless, if you're over State Pension age (currently 66), you're exempt from National Insurance deductions, though your employer still pays their share [4].
Step 2: Learn How Your Tax Is Calculated
Understanding your tax calculation gives you greater control over your finances. This knowledge helps you verify whether you're paying the correct amount and identify potential refunds.
How tax codes work
Your tax code determines how much Income Tax your employer deducts from your salary. It typically consists of numbers followed by a letter, for example, 1257L [8]. The numbers indicate how much tax-free income you can receive each year, while the letter relates to your personal tax situation [9].
For most employees with a standard Personal Allowance, the tax code for 2025/26 is 1257L [8]. This means you can earn up to £12,570 without paying tax. The 'L' indicates you're entitled to the standard Personal Allowance [8].
Other common letters in tax codes include:
- M: You've received a transfer of 10% of your partner's Personal Allowance
- N: You've transferred 10% of your Personal Allowance to your partner
- T: Your tax code includes other calculations to determine your Personal Allowance
- BR: All your income from this job is taxed at the basic rate (usually for second jobs) [8]
Emergency tax codes (ending with W1, M1, or X) are temporary measures used when HMRC lacks sufficient information about your income [8].
What is your personal allowance
The Personal Allowance is the amount you can earn before paying Income Tax. For the 2025/26 tax year, the standard Personal Allowance is £12,570 [10].
For high earners, this allowance gradually reduces. Your Personal Allowance decreases by £1 for every £2 you earn above £100,000. If you earn £125,140 or more, you receive no Personal Allowance at all [10].
After your Personal Allowance, Income Tax rates apply in bands:
- Basic rate: 20% on earnings between £12,571 and £50,270
- Higher rate: 40% on earnings between £50,271 and £125,140
- Additional rate: 45% on earnings over £125,140 [11]
How National Insurance is deducted
National Insurance contributions fund state benefits, particularly the State Pension. Unlike Income Tax, which is calculated cumulatively throughout the year, National Insurance is calculated on each pay period independently [12].
For 2025/26, employees pay:
- 0% on weekly earnings up to £242 (£1,048 monthly)
- 8% on weekly earnings between £242.01 and £967 (£1,048.01 to £4,189 monthly)
- 2% on weekly earnings above £967 (£4,189 monthly) [13]
For example, if you earn £1,000 weekly, you'll pay nothing on the first £242, 8% (£58) on earnings between £242.01 and £967, and 2% (£0.66) on the remaining £33 [13].
Other deductions like student loans or benefits
Student loan repayments are automatically deducted through PAYE if you're earning above the repayment threshold. The amount deducted depends on your loan type and income level.
You may qualify for a deduction of up to £1,985.40 for student loan interest paid during the tax year [14]. To be eligible, you must:
- Have paid interest on a qualified student loan in 2024
- Be legally obligated to pay interest
- Not be filing as married filing separately
- Have a Modified Adjusted Gross Income below specified thresholds [14]
If you paid more than £476.50 in student loan interest during the year, you should receive a Form 1098-E Statement from your loan provider [14].
Additional possible deductions might include:
- Workplace pension contributions
- Attachment of earnings orders
- Salary sacrifice arrangements
All these deductions should appear clearly itemised on your payslip, allowing you to verify the calculations.
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