Payroll Deductions Explained

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Payroll deductions explained

Have you or your employees asked: why do I have that deduction on my payslip? This post will give you insight into what deductions are and how they are calculated. The three most common deductions are Income Tax, National Insurance and Pension Contributions.

Income Tax

Income tax is the government’s main source of revenue and is collected by HM Revenue & Customs (HMRC) on their behalf, it is most commonly collected via the PAYE (payroll) system. The government uses income tax revenue to fund public services.

Income tax is calculated based on your yearly gross income and your tax code (click here for more info on tax codes). Your 2020/21 personal tax allowance is £12,500, so you pay no tax on earning within this band. The basic tax rate is 20% and this is deducted from your earning between £12,501 and £50,000. Your earnings between £50,001 and £150,000 are taxed at the higher rate of 40%. Finally, earnings over £150,001 are taxed at the additional rate of 45%.

National Insurance

National Insurance contributions are collected by HMRC. These funds are used to help pay for state benefits including the state pension and your contributions will be used to decide your entitlement to these.

Employees and Employers both pay Class 1 National Insurance. Employees pay 12% on earnings above £792 per month and 2% on earnings above £4,167 per month. Employers pay 13.8% of earnings above £732 per month.

Pension contributions

As of October 2012 the government made it compulsory for employers to auto-enrol eligible workers into a qualifying workplace pension scheme. Employees are entitled to opt-out of the scheme if they would prefer not to contribute. Contributions are based on qualifying earnings which are anything between £6,240 and £50,000 for 2020/21. Employer contributions are 3% of qualifying earning and Employee contributions are 5% of qualifying earning less tax relief. 

Payroll worked example

Based on the above information monthly deductions for an employee on an annual salary of £24,000 would be as follows:

For more information and advice on Payroll and deductions contact our team of payroll experts.

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