As a payroll professional and an employee, I’m in a privileged position. I know for sure that every entry on my payslip is correct – the salary, the tax deductions, the pension contributions, everything. We work closely with our clients to ensure the accuracy of each and every payslip we produce but sometimes an employee will look at their payslip and question what all the deductions are and why they’ve received less cash than they did last month.
In these confusing and worrying times, we’re receiving a lot of enquiries from employees asking for clarification of their pay. Below is a brief explanation as to what each payslip entry means and how it is calculated:
Unless specifically defined in an employee’s contract as a set amount per pay period, this is calculated as follows:
Contracted hours per week × Hourly rate of pay × 52 weeks ÷ 12 months
35 hours per week × £12.00 per hour × 52 weeks ÷ 12 months = £1,820 (salary)
Income tax is used by the Government to “provide funding for public services such as the NHS, education and the welfare system, as well as investment in public projects, such as roads, rail and housing”.
The tax deduction on a payslip is normally based on an employee’s tax code. Every employee has their own code and it’s nearly always made up of some numbers and a letter:
- The numbers refer to how much income you can have before you pay tax;
- The letter refers to the employee’s situation and how it affects their tax-free Personal Allowance.
In the vast majority of cases it’s the number part of the code that is the most important as it sets how much tax an employee will pay.
First, we calculate the employee’s tax-free allowance using their tax code:
Tax code number × 10 ÷ 12 months = Tax-free allowance
For example, if an employee’s tax code is 1250L,they will be able to earn the following amount each month without paying tax:
1250 × 10 ÷ 12 months = £1,042
This tax-free allowance is then deducted from the employee’s salary to give taxable income. The result is multiplied by 20% to give the employee’s tax deduction. For example:
£1,820 (salary) – £1,042 (tax-free allowance) = £778 (taxable income)
£778 × 20% = £156 (tax deduction)
National insurance contributions are paid by both the employee and the employer and are used by the Government to “build your entitlement to certain state benefits, such as the State Pension and Maternity Allowance”.
Every year the Government produces an annual budget report that sets out the amount an employee can earn without paying national insurance. For 2020/21, that amount is £792 (NI-free allowance).
This NI-free allowance is then deducted from the employee’s salary to give NI-able income. The result is multiplied by 12% to give the employee’s national insurance contriubution. For example:
£1,820 (salary) - £792 (NI-free allowance) = £1,028 (NI-able income)
£1,028 × 12% = £123 (NI deduction)
Auto-enrolment Pension Contribution
For employees earning over £10k per year and aged between 22 and the state pension age, employers are required to automatically enrol them in a workplace pension scheme. Pension contributions are paid by both the employee and the employer and are a way of helping an employee to save up towards their retirement. Contributions are taken and invested in an employee’s own pension pot which can be accessed upon their retirement.
Every year the Government sets out the amount an employee can earn without having to make a pension contribution. For 2020/21, that amount is £520 (pension-free allowance).
This pension-free allowance is then deducted from the employee’s salary to give pensionable income. The result is multiplied by 4% (i.e. 5% after tax relief) to give the employee’s pension contribution. For example:
£1,820 (salary) - £520 (pension-free allowance) = £1,300 (pensionable income)
£1,300 × 4% = £52 (pension contribution)
Net Pay or Take-Home Pay
This is the amount that will land in the employee’s bank account at the end of each month. It’s the amount of salary left after all the items mentioned above are deducted:
Salary – Tax – National Insurance – Pension = Take-home pay
£1,820 – £156 – £123 – £52 = £1,489 (net pay)
There are other items that could appear on an employee’s payslip (e.g. student loan deductions; attachment of earnings orders) but 99 out of 100 payslips will show all five of these elements.
As a final point of interest, if an employee has been working from home during the lockdown, they may be entitled to claim tax relief to cover some of the additional household costs they may have incurred. Further details can be found on the gov.uk website.