What is Payroll? Managing employee payments in the UK

Defining payroll

What is payroll? It’s basically the process organisations use to pay their employees the right amount at the right time. For most businesses, it’d be almost impossible to manage this on a person-by-person basis, so payroll is an effective system for getting everything under control. 

As well as making sure everyone gets paid, payroll also helps businesses to follow their legal obligations, like real-time information reporting and pension auto-enrolment. We’ll go into more details about these later.

The components of payroll 

Some elements of payroll include:

Payroll Breakdown: From Gross Pay to Take-Home

Different types of pay

The exact information in a payroll may vary depending on the payment structure of your employees.

It could be any of the following:

Then there are statutory benefits to think about, such as sick pay, maternity or paternity pay, and parental pay. Remember that contractors or freelancers are paid differently. They take care of their own National Insurance contributions and aren’t entitled to pensions, sick pay, or similar benefits. 

How to pay your employees

Once you’ve calculated how much you need to pay your employees, you’ll need to actually process the payments.

Methods of employee payment

We’ve outlined the main payment methods in the table below.

Legal requirements for payroll in the UK

There’s more to payroll than just paying your employees. You also have to ensure that everything complies with tax laws and employment legislation.

Minimum wage compliance

Employers must make sure they’re paying the National Minimum Wage (for those aged 20 or under) or the National Minimum Wage (for those aged 21 or above).

It’s particularly important to be aware of this if your employees are earning a fixed salary. You can calculate an employee’s equivalent hourly salary by dividing their fixed salary by the total hours worked. 

We’ve detailed the minimum wage rates by age group in the chart below.

UK National Minimum Wage by Age Group (as of 6 April 2025)

Pay frequency

You can choose whether to pay your employees on a weekly, fortnightly, four-weekly, or monthly basis.

Most organisations opt for monthly pay since it makes it easier to keep track of payments and helps you to keep up with HMRC deadlines.

However, some employers opt for shorter gaps between payments to help their staff members manage their money.

Tax and National Insurance Contributions

Employers are responsible for deducting tax and National Insurance from their employees' wages.

As of the 2025-2026 tax year, the PAYE tax rate is 20% up to £37,700, 40% from £37,701 to £125,140, and 45% over £125,140.

National Insurance rates are more complicated, and vary depending on an employee’s earnings and category. The latest rates are available on the HMRC website.

Pension Auto-enrolment

Every UK employer must auto-enroll eligible employees into a workplace pension. The minimum contribution is 8%, with employers contributing at least 3% and the employee contributing 4% (with the government providing the final 1% through tax relief).

Setting up payroll for the first time

Let’s walk through the process of setting up your payment system.

1. Register with HMRC as an Employer

First of all, you have to register as an employer with HMRC. 

After you register, you’ll get your PAYE reference number, which allows you to start running your payroll.

2. Choose your payroll method

Then you can choose your payroll method of choice. Will you go for a dedicated software or a manual system? Use an in-house team or outsource the job to a professional?

3. Start record keeping

You’ll need to record the salary or wages of your employee as part of the process, alongside other benefits and your deductions. This is really important if you want to avoid penalties from HMRC.

4. Set up your first employee

When you set up your first employee, you’ll need to add information about their salary, deductions, tax codes, annual leave, and more.

If they don’t have a P45, you’ll need to register them with HMRC to work out their tax code through a New Starter form.

5. Preparing your first pay eun

Once everything is ready, you can begin your first pay run.

You’ll need to record what you’re paying, calculate deductions, work out contributions, make a payslip, and report everything to HMRC. The software you’re using will usually provide a payslip.

Regular payroll process

Let’s explore the process in more detail so you can really nail your payroll.

Determining pay and compensation

You already know you need to pay your employees at least the minimum wage, but working out their exact salary can be tricky. As a starting point, it may be helpful to research the salary and benefits package of comparable organisations in your industry for an employee with a similar experience level.

If your employees are working overtime, you may need to adjust their holiday pay. Holiday pay is based on an employee's average earnings over a 52-week reference period, which must include overtime. However, there are some exceptions, such as the case of occasional overtime.

You’ll need to record paid time off (PTO), but when an employee is on leave, you should still calculate their pay as though they’re working. Some employers offer accrued PTO (meaning employees accrue more days over the pay period), a fixed number of PTO hours per year, or even unlimited PTO.

Processing payroll

You start with gross pay – that’s the total amount an employee earns before taxes or deductions. Net pay includes these deductions. 

So to calculate an employee’s gross pay, just add their base salary and any additional benefits or payments they receive (such as a travel allowance, commission, or overtime payments).

Then, to calculate net pay, deduct any of the following that apply:

Employers in the UK are legally required to provide their employees with payslip. If you’re using payroll software, it will generally include a feature that generates payslips for you. This should include gross pay, net pay, and all the deductions.

Making payments

If you want to change your payday at any point, just add the new payment into the system as an additional payment. 

However, if you want to make a change to your payment schedule that will lower the frequency of payments, you’ll need to contact HMRC to avoid a penalty.

Reporting and compliance

Every time you pay your employees, you must send a Full Payment Submission (FPS) to HMRC outlining their payments and deductions. To do this you have to enter details about the employee’s gross pay, employment information, and personal information into your payroll system.

This is part of HMRC’s Real Time Information (RTI), which requires employees to report their payroll in real time by submitting an electronic report before each payment to employees.

“For example, by removing the need for the end of year return (P35 and P14) and simplifying the employee starting and leaving processes.” — HMRC.

If there are any changes, such as an employee leaving or changing their address, you’ll need to update this in your systems.

At the end of the tax year, there are some additional admin tasks. For instance, you’ll need to give all employees on your payroll a P60 form to show how much tax they’ve paid over the fiscal year.

Here are some important reporting deadlines to be aware of:

Using payroll software and outsourcing

When it comes to running your payroll, one of the biggest decisions to make is whether you should outsource the job to a professional or manage everything in-house using software.

How to choose a payroll software provider

If you decide to take the software route, here are some things to consider:

Advantages of payroll software

Manual processes are one of the biggest culprits for payroll mistakes, as they leave too much room for human error. Payroll software helps to improve accuracy by automating processes and flagging potential errors. 

Plus, most programs offer compliance features to help you ensure you’re meeting HMRC’s requirements. Automation also helps you save time.

When to consider outsourcing payroll

For organisations with 5 or more employees, it may make sense to outsource your payroll function to an accountant or professional rather than handling it in-house. This will free up time, give you significant peace of mind, and help you to scale up your business.

Common payroll mistakes to avoid

Getting your payroll right can be tricky, and lots of companies make the same mistakes. Below, we’ve listed the most common errors.

What should you do if an employee doesn't receive their payment?

If an employee isn’t paid you may have made a mistake on your payroll. Check your system for errors and then send the payment to the employee as soon as possible.

It’s not just good manners – late payments are illegal under the Employment Rights Act and may lead to a penalty.

Misclassifying workers

Sometimes, employers misclassify their employees as contractors and vice versa. It’s important to make sure you select the correct category for your team and follow the appropriate rules. If an employee has been misclassified, you need to reclassify them, which may include paying employment benefits they were owed retroactively.

Missing payroll tax payments

If you’ve missed a PAYE tax or NIC payment, you may need to pay interest and penalties to HMRC. How much you owe will depend on how late the payment is and how many times you missed a payment.

Using payroll software helps you to reduce all the risks mentioned above.

The future of payroll management

Right now one of the biggest trends in payroll technology is AI. This is taking payroll software to the next level by automating processes, helping businesses to detect fraud, reduce errors, and receive real-time analytics about their pay processes. 

While this stands to make payroll management easier for businesses, employers also face increasingly complex regulations. The UK has introduced various new or updated laws in recent years, such as changes to the National Minimum Wage and Holiday Pay. It’s important for companies to make sure they stay up to date with this.