PAYE tax workings with mathematical calculator and brown pencil

PAYE codes: 1185L…K487…S1185L. What do they all mean? The financial cyphers applied to your wage slip can be daunting. Consequently, understanding your Tax Code can save you £100s and make life a whole lot simpler. This handy guide gives you back control to ensure you are paying the correct amount of Income Tax and National Insurance.

What is PAYE?

PAYE means “Pay As You Earn”. Before you even get paid, income tax is already deducted ‘at source’. Because of this, it is the way most employees pay Income Tax and National Insurance.

Crucially, it’s easy and tax is collected automatically ‘at source’ as you earn.

This is in contrast to “Self Assessment” which is used by the self-employed. In this instance, the onus is on the individual (or their accountant) to calculate and pay tax once or twice a year, which can take up a whole lot of time.

A tax year runs from April 6th one year to 5th April the next.

What is Self-Assesment?

Self-Assessment is a form of tax return. If your only income is from your salary, wages or pension, you do not need to file a tax return as this is usually done by PAYE

However, there are exceptions:

  • You earned over £1,000 as a sole trader / self-employed
  • If you are a partner in a business partnership
  • Have un-taxed income from:
    • property rental
    • tips and commission
    • savings, investment or dividends (excludes Premium Bonds which are tax-free)
    • foreign income
  • Have an annual income over £100,000

How does PAYE work with Pensions?

If you’re retired, PAYE can also be used to deduct tax from pensions. In this scenario, HMRC (ie, the ‘tax man’) will instruct your pension provider to deduct Income Tax directly, rather than have to manually calculate it each year. Your income will need to be above the thresholds detailed below.

The official Government site is a good place for more information on Tax and Pensions

What is a P60?

Each year, after April 5th, a P60 is automatically gets issued to you. You’ll often find it accompanies your April payslip from your employer.

Your P60 shows things such as:

  • Earnings during that tax year
  • What you’ve paid in Income Tax
  • Your National Insurance contributions

How is PAYE calculated?

The amount of PAYE tax you pay is based on your income and your eligibility for the Personal Allowance.

This calculation is reflected in your Tax Code, which is a combination of letters and numbers that is used by HMRC to tell your employer or pension provider how much tax to deduct from your pay.

If you have just started a job, your employer might not be able to obtain the correct tax code in time. If this happens, an Emergency Tax Code will be applied.

The most common tax code (tax year 2018/19) is 11851L. Typically, this code is used for most people with a single job and no additional untaxed income (such as interest on savings), unpaid tax or taxable benefits (for example a company car).

What is a tax code?

Tax codes are all about your taxable allowance and are made up numbers and letters. Importantly, they each mean different things. Let’s use 11851L as an example:

  • Numbers – show your allowance of income that you can earn which you are not taxed on. In our example, the first £11,185 is not taxed.
  • Letters – refer to the type of allowance you get. In the example above, ‘L’ means your eligible for the basic personal allowance.

Taxable income is based on your personal circumstances and Government legislation at the time. For example, the basic Personal Allowance for the tax year 2018/2019 is £11,185. In 2019/20 this is due to rise to £12,500. As a result, in that year you can earn more before you start paying tax and will, therefore, be better off.

For more information on understanding your tax code at HMRC, click here.

How much PAYE tax should I be paying?

Income Tax is based on your income and calculated in four ‘bands’.

The first band is your Personal Allowance and is tax-free. This means you do not pay tax on any income up to your Personal Allowance threshold.

The second band is the Basic Rate of tax. The PAYE system will deduct 20% of any income between the lower and upper thresholds (check the table below). About 80% of employees fall into this category, according to the BBC.

The Higher Rate is the third band and applies the same principle. Crucially though, tax is now taken at 40% of any income within the thresholds. About 13-14% of all UK employees fall into this category.

The final threshold is the Additional Rate if your’re lucky enough to worry about such things. For the privelage, you are going to lose an eye-watering 45% of any income above this threshold.

What are the PAYE Tax Bands?

Here are the current four Tax Bands and their thresholds for the current and next tax year.

Tax Band 2018/19 2019/20
Personal allowance£0 – £11,850£0 – £12,500
Basic-rate (20%) £11,851 – £46,350£12,501 – £50,000
Higher-rate (40%)£36,351 – £150,000£50,000 – £150,000
Additional-rate (45%) £150,001+ £150,001+

Pro Tipnot sure if you have the correct tax code? Click here to check.

What is National Insurance?

By paying National Insurance at source, you’re building your entitlement to state benefit such as the state pension. Importantly, remember that NI is in addition to the tax bands above.

  • 12% of any income between £162 and £892 per week
  • 2% for any earnings above £892 per week

These rates change in April 2019 to 12% on any income between £166 and £962 per week and 2% for anything above this.

National Insurance rates differ in Scotland. For more information click here.

How do I caluclate my Income Tax and National Insurance?

A common question when reviewing your payslip is – am I paying the correct amount of tax? It can be really confusing and intimdating when trying to work this out.

This nifty calculator site can be used to work out how much tax you should be paying. It provides a useful weekly, monthly and annual breakdown advising how much tax you should be paying.

What are emergency Tax Codes?

If HMRC cannot supply the correct tax code to your employer, an Emergency Tax Coe will be applied.

They can, however, be pretty horrific, costing you up to 50% of your wage.

The good news is that this is usually a temporary issue and occurs when starting a new job part way through a tax year.

If your tax code ends in these suffixes, you can be fairly sure you;ve got an Emergency Tax Code on your hands:

  • W1
  • M1
  • X

For example, 1185L-W1 is a typical Emergency Tax Code.

Your employer and HMRC will usually quickly resolve an Emergency Tax Code, automatically adjusting any overpaid or underpaid tax. As always though, it’s best to be proactive by checking up on these things and telling HMRC about your new employer.

You will stop paying any Emergency Tax Code at the start of a new tax year (April 6th). After that, your employer will then start taxing your salary as normal. You can claim back any overpaid tax from HMRC.

How to claim back overpaid tax?

HMRC will often automatically issue repayment if you’ve overpaid tax such as at temporary Emergency Tax code. You may, however, need to manually request an adjustment and repayment if you haven’t been notified by HMRC via a P800 caluclation.

For a more detailed guide on claiming back tax, follow this guide.

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PAYE – How to decipher the codes and save £100s