Welcome to the payroll deductions maze. Well, more like a personalised, individual labyrinth for each employee in the United Kingdom — as every single person’s payroll deductions situation is unique to them. This gives payroll teams plenty to get stuck into.
Today, we will go into the specifics and where companies’ responsibilities lie in administering payroll deductions in the UK to discover how the right payroll software can manage this complex system effectively. So you can perfect your payroll, for both an individual employee and a company as a whole.
UK payroll deductions
Put simply, payroll deductions are the monies that have to be removed from employees’ gross wages before they are paid to them. Many of these payroll deductions are required by British law, so they cannot be ignored.
Some of these payroll deductions have to be paid by everyone via the UK’s HM Revenue and Customs (HMRC) system. These payroll deductions include income tax and National Insurance Contributions (NIC), which go towards the running of the country, including maintaining infrastructure, social care and healthcare. Whereas other payroll deductions like pensions, student loans and charitable contributions are dependent on the company individuals work for and their personal circumstances.
If you work in payroll, here are the big four payroll deductions you need to think about in the UK…
1. Income tax
Incoming, always incoming. Employees in the UK are subject to income tax, through automatic payroll deductions from earnings through the PAYE (Pay As You Earn) system. Paying as you earn is more manageable for most people, as there’s no big tax bill at the end of each tax year. Income tax thresholds depend on which salary bracket employees fit into, a key part of payroll. It all kicks off with a personal tax-free allowance up to a fixed amount for every employee and self-employed person in the UK, sitting at £12,570 per person as of January 2024.
An ode to the tax code. Tax codes underpin the UK’s system of income tax. A tax code is a mixture of numbers and letters that denote an employee’s personal circumstances, tax allowance and pension situation. Incorrect tax coding is often a place where PAYE payroll errors can be made — assign the wrong tax code and an employee’s annual contributions can be completely out of whack and complicated to fix. This is the great advantage of payroll software; it can keep tax codes up-to-date and organised to avoid mistakes, which can be extremely frustrating for employers and employees alike as well as, potentially, financially costly.
2. National Insurance Contributions (NIC)
Nicely does it with NICs. The UK has one of the world’s earliest national insurance systems, passed into law in the National Insurance Act (1911). In Britain, National Insurance Contributions (NICs) fund various state benefits, NHS healthcare and the state pension and are a legal requirement for both companies and individuals. NIC payroll deductions are taken by the government from both employers and via PAYE for employees. Like income tax, NIC payroll deductions for individuals are dependent on an employee’s earning percentile with high-income brackets contributing more and some groups, like under-16s and people over the state pension age, being exempt.
Keep it classy, Britain. NICs are broken down into four classes with people paying different amounts depending on income level, age and individual situation. For example, Class 3 is voluntary contributions to make up for any NICs years missed in order to meet the full state pension threshold. Payroll software can keep these all current and on point, so both employees and employers’ NCIs payroll deductions are correct and paid in timely fashion to avoid any late fee penalties.
3. Pension contributions
Pensions? That old chestnut. Pension contributions are payroll deductions that again come out of an employee’s gross pay; however, this money goes into a pension pot chosen and administered by the employer, separate to the UK state pension. However, that doesn’t exempt pension contributions from UK legal oversight and payroll clarity is needed to protect workers from the high-profile pension scandals and bailouts in preceding years. For the last decade, the British government’s automatic enrolment programme has meant that employees are auto-enrolled into workplace pension schemes, without employees having to explicitly opt in. Along with pension provision websites and software, automatic pension enrolment means more transparency and accessibility for workers at all levels. Today, Britons have a longer life expectancy than ever, so it’s good for people to know their pension status such that they can look forward to older age with more confidence and security.
Plan to plan for the future. Through automatic enrolment, it’s the HR and finance team’s obligation to collect payroll pension contributions from UK employees’ wages, often matching a certain level of pension contributions from the company’s purse. Pensions contribution payroll deductions will vary role by role, industry by industry, but usually mean a specific percentage of salaries going into the company-wide pension scheme. Generous pension provision is a tangible benefit that can help attract the best employees, especially at C-Suite level, so understanding and administering this correctly is essential. Think about your payroll software provider to make sure everything is accurate and accounted for, as corporate pension management is a hot-button reputational issue — and managing it transparently and ethically is the right thing to do for every employee.
4. Student loan repayments
Since the mid-1990s in the UK, people doing undergraduate degrees have been able to take out student loans to pay towards their tuition fees and living costs whilst they studied. The government-owned Student Loans Company then takes repayments automatically from graduates via the PAYE system, with salary level and income dictating the amount of payroll deductions to be taken out of their wages every month. Postgraduate loans deductions can also be taken via PAYE payroll on top of undergraduate loans, again with repayment levels attached to earnings but under a stricter and shorter loan repayment plan.
Obviously, not every employee has been to university or taken out a student loan. Therefore, such payroll deductions need to be done on an individual basis, alongside income tax calculated by the HMRC via the PAYE system. Depending on when people studied, repayment terms will be one of four different student loan repayment plans — so employees need to be on the correct numbered plan for them. So, HR and finance teams have to be across this as it’s included in payroll and on payslips for employees to see. Thankfully, student loans repayments are usefully integrated into UK payroll software.
Other payroll deductions
We’ve covered the four main pillars of payroll deductions, now here’s everything else.
- Payroll Giving: Payroll Giving is a way of giving to charity directly from your gross pay via PAYE contributions, without having to pay tax on it. So charities get more income from regular giving by individuals and companies.
- Overpayment of wages: As per an agreed contract, an employee may be required to repay some wages from an error, overpayment or an unexpected change in a situation. This can come out as an automatic payment via payroll; however, this must be a reasonable, manageable amount so as not to cause an employee hardship.
- Overpayment of benefits: The Department of Work and Pensions (DWP) can recover overpaid benefits directly from an employee’s earnings using the PAYE payroll system, known as a Direct Earning Attachment (DEA).
- Court-ordered repayments: Any payroll needs to be aware that as a result of a County Court Judgement (CCJ), for example an unpaid council tax bill or another unpaid debt, an organisation can obtain an Attachment of Earnings Order (AEO) to recover money as a percentage of an employee’s net pay, after income tax and NCIs.
- Child maintenance: Following a Child Support Agency (CSA) decision, a parent can be legally required to pay a certain amount or percentage of their net wages to the other parent via a legally binding Deductions from Earnings Order (DEO). Payroll should make deductions in line with such orders.
- Payroll saving schemes: To help employees out, some companies offer loans and advances via ethical non-for-profit credit unions, regulated by the Financial Conduct Authority (FCA). Some also offer saving schemes to help lower income employees save for the future. Therefore, these payroll deductions need to be included accordingly.
Payroll software can manage it all
As we’ve seen, the British system of payroll deductions is far from a one-size-fits-all endeavour but varies greatly from person to person depending on their age, marital status, education, shoe size… well, not quite that much, but it can feel like it!
Fortunately, payroll software does just the job. A modern payroll system is ideal for juggling such a complicated array of payroll deductions. Especially, as many payroll deductions are required by law and subject to penalties if improperly calculated and administered. Therefore, comprehensive and efficient payroll software like ADP — specifically built to understand the intricacies and needs of the whole UK tax system is essential for any organisation to get payroll and payroll deductions accurate and compliant at every step.