If you have employees or want to pay yourself a wage, then you need to know and get payroll right.
With different aspects and systems that you can use, this might seem like a daunting task. But in this payroll for dummies guide, we’re here to prove that payroll might be simpler than you think.
Read on to understand the ins and outs of UK payroll and how to set it up for your company.
Payroll for dummies: what is payroll?
Payroll is how businesses pay their employees. It’s designed to cover employees’ wages, the financial records of the pay, and the process of paying any corresponding tax to the HMRC.
In a nutshell, payroll is the entire process that handles an employee’s wage and tax. The physical payout of wages and taxes is handled by PAYE (Pay As You Earn), which is a UK government scheme administered by HMRC.
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Do you need to use payroll?
If you have any employees, then you need to set up payroll. Failure to do so will result in some hefty fines and penalties against your company, so as soon as you hire someone you need to sort payroll out ASAP.
Generally, this only takes 3 steps.
- Register your business as an employer through HMRC.
- Register your employee with the HMRC using a Full Payment Submission (FPS). For this, you’ll need details such as your employee’s full name, address, tax code, date of birth, start date, salary and student loan information. You’ll also need their P45.
- Set up your PAYE system and begin your payroll process.
The set-up for payroll is relatively simple, but there are steps that you have to do every month to make sure that you pay your employees and tax correctly.
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How to run monthly payroll
A tax month runs from the 6th of one month to the 5th of the next. Each tax month, your business will have to complete some actions to make sure that your payroll is correct and compliant.
These actions can be completed using payroll software. If you don’t have payroll software, you can research and choose one from a list of HMRC-approved software here.
- Record the pay of all your employees, whether it’s salaried or hourly.
- Calculate all deductions from their pay, including Income Tax and National Insurance contributions. You can read more about deductions later in this guide.
- Calculate the amount of National Insurance that you’ll have to pay as an employer. This is a fixed rate of 13.8% per employee over 21 years old.
- Produce payslips for your employees.
- Report all pay and deductions to the HMRC using an FSP (Full Payment Submission).
Once completed, you’ll be sent a balance of what you owe the HMRC in your online account within 2 days. This payment is due by the 22nd of each month unless you pay less than £1,500 a month, in which case you can apply to pay quarterly payments instead.
Any late or incorrect filings can occur a penalty charge, so it’s important that you get this information right and on time.
Do you need to have employees to use payroll?
No – payroll isn’t just for businesses that employ others. Sole employees can use payroll to pay themselves a wage via PAYE, which could be a more preferable option depending on how you work.
However, you must be registered as a limited company in order to pay yourself through the PAYE system.
In order to do this, you’ll need to register your company as an Employer with the HMRC and register for self-assessment if you haven’t already. Then, you can use the payroll system to pay yourself as the sole employee of your company.
If you don’t want to use the PAYE system, you can pay your wages through dividends instead, which distribute the share of profits to all shareholders. This method doesn’t pay National Insurance Contributions, so could earn you more money in the long term. However, paying dividends is dependent on the profits that your company makes. If you have a bad month as a business, you won’t get any dividends.
In addition, dividends stop you from reinvesting funds back into the company, as all profits are withdrawn and distributed.
If you want a steady paycheck and more funds to grow your business, payroll systems are your best option.
Can sole traders use payroll?
No, sole traders can’t pay themselves a traditional wage using PAYE.
As a sole trader, there’s no legal distinction between you and your company. The wages that you pay yourself are from personal drawings of the business, while the Income tax and National Insurance will be based on the profits that your business receives. Although you can’t give yourself a wage through the PAYE system, you will need to keep a detailed record of all the payments you make yourself in order to correctly calculate profits and tax.
If you’re a sole trader, it’s recommended to set aside a certain amount every year to make sure that your tax contributions are fully covered. The following table can be used to calculate roughly how much you should set aside from your earnings.
|Drawings per annum||% to set aside for tax|
For example, if you draw £40,000 a year as your ‘wages’, you’ll want to set aside £10,000 to cover your tax and national insurance contributions, as they’re not automatically coming out of your wages.
To make sure that your books are right, we’d always recommend speaking to an accountant to ensure that your tax is correctly calculated and paid on time.
Do you have to handle payroll yourself?
Running a small business, we know you have a lot on your hands. If you don’t have the space or know-how to take on payroll, you can outsource it to other companies or agencies to handle it on your behalf.
In fact, a 2020 report from the UK Chartered Institute of Personnel and Development (CIPD) shows that 39% of small businesses in the UK outsource their payroll, making it the most commonly outsourced HR function.
However, it’s worth noting that even if you outsource your payroll, it’s still the legal responsibility of your company.
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What payroll legislation do you need to know about?
Payroll has several legislations attached to it under UK law. If you’re carrying out payroll in another country, you will need to check local laws and guidelines to avoid any costly mistakes.
The main UK legislation for payroll is:
Employment Rights Act 1996
This act was designed to protect employees from unfair treatment and dismissal. For payroll, the Employment Right Acts underlines the different contract types that you can offer, what salary deductions you can and can’t make, and an employee’s entitlement to paid time off work. For a full-time worker, paid time off amounts to 28 days of paid holiday. For part-time workers, you can calculate their time off using this gov.uk tool.
National Minimum Wage Act 1998
The UK has strong minimum wage legislation which applies to all workers, no matter if they’re paid hourly or on a fixed salary. This rate can change, but for the 2020/2021 tax year, they were recorded as the following:
|Age||Minimum wage per hour|
|Apprentice (under 19 or in first year of scheme)||£4.15|
|25 and over||£8.72|
Part-Time Workers (Prevention of Less Favourable Treatment) Regulations 2000 and Agency Workers Regulations 2010
These two acts work together to protect part-time workers from being treated unfairly compared to full-time workers, including receiving the same hourly pay, overtime conditions, and pension options.
Income Tax (Earnings and Pension) Act 2003 and Income Tax Act 2007
These acts set out the rules and payments for Income Tax that you need to follow for your payroll. Generally speaking, the first £12,500 of income is tax-free, and then any amount after this occurs tax. This is a rate of 20% for income up to £50,000, 40% for income up to £150,000, and 45% for any income over £150,000. For most small businesses, your employees will be on an income tax rate of 20%.
National Insurance Contributions Act of 2015
These acts set out the rules and payments for National Insurance Contributions that you need to follow for your payroll, which we’ve covered the basics of in this UK payroll guide.
Pensions Act 2008
All employees must provide and contribute to a pension fund for staff aged over 22. This is an off-opt process, which means you must auto-enroll and inform your staff in this process unless they choose to opt-out. Failure to set this up could result in fines of between £400-£10,000.
If you’re unsure of any legislation surrounding payroll, make sure that you get legal advice to avoid any hefty fines or potential prosecution.
What PAYE deductions are there?
Paying your employers through PAYE makes sure that your employees are paid the right amount and that you don’t need to worry about tax deductions at a later stage.
Generally, a PAYE slip starts with gross pay. This is the salaried or hourly amount that an employee has earned.
So for example, if an employee earns £30,000 a year, their gross salary would be £25,000. From this salary, every employee would be required to deduct National Insurance and Income Tax.
Employee National Insurance is calculated at:
- No payment on income below £792 per month;
- 12% for income between £792 and £4167 per month;
- 2% for income over £4167 per month.
In addition, if they are over the age of 22 and earn a salary above £10,000, they will also be enrolled in a pension contribution scheme which has a minimum 5% contribution from the employee, unless they are opt-out. For this example, their PAYE wage slip would look like this.
|Gross Monthly Salary||£2,500|
|National Insurance Contribution||£205|
|Pension Contribution (5%)||£99|
In addition to these amounts, there are set costs for an employer to pay on top of this.
This includes Employer National Insurance, which is set at a fixed rate of 3.8% of all earnings above £732 per month. The only exception to this is if an employee is aged under 21, which doesn’t attract any Employer Insurance Contributions as long as they are not earning more than £4167 per month.
Employers are also required to contribute an extra 3% (or more) to pensions for all employees that are enrolled in the scheme.
Using the same example above, this would be the cost to the employer per month.
|Gross Monthly Salary||£2,500|
|Employer National Insurance Contribution||£345|
|Pension Contribution (3%)||£75|
|Total monthly cost||£2,920|
Other deductions include Student Loan Repayments, which depend on the repayment plan an employee is on and their income.
The guidelines for this are:
- 9% of income over £19,390 on Plan 1;
- 9% of income over £26,575 on Plan 2;
- 6% of income over £21,000 for postgraduate loans.
There may also be circumstances where you need to add extra deductions onto a PAYE slip.
For example, if an employee exceeded paid holiday or sick days, or if they enrolled on a wage contribution scheme, such as sacrificing a partial amount of their net wages to buy a car or bicycle through the company.
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