PAYE Tax NI Explained

The Basics of PAYE Tax and NI Explained for Graduates

Starting your first full-time job after university brings a lot of new responsibilities, and understanding your payslip is right at the top of the list. When you receive your monthly pay, you will notice that the amount deposited into your bank account is lower than your official annual salary. This difference is due to Pay As You Earn (PAYE) tax and National Insurance (NI) contributions.

Employers use the PAYE system to deduct Income Tax and National Insurance directly from your wages before paying you. This system ensures you pay your taxes gradually throughout the year rather than facing a massive bill at the end of the tax year in April. According to GOV.UK (2025), the current tax year runs from 6 April 2025 to 5 April 2026.

If you decide to work as a freelancer or start your own business, you will not use the PAYE system. Instead, you will need to register for Self Assessment and manually declare your earnings to HMRC each year. For the vast majority of graduates entering traditional employment, PAYE removes this administrative burden. Your employer calculates the exact amount of tax you owe based on your tax code and sends it directly to the government on your behalf. This means the money landing in your bank account is entirely yours to spend or save.

If you are earning around this average graduate salary, you will be paying both Income Tax and National Insurance. Getting to grips with these deductions helps you budget effectively. If you are planning to move out of your student accommodation and into a professional flatshare, you need to base your budget on your net income (take-home pay) rather than your gross salary. You can use our student budget calculator to work out your monthly living costs based on your actual take-home pay.

How the UK Personal Allowance Impacts Your PAYE Tax

Before you pay a single penny in Income Tax, you benefit from the Personal Allowance. This is the amount of money you can earn each tax year completely tax-free.

If your total annual income is below £12,570, you will not pay any Income Tax. Once your earnings exceed this threshold, you only pay tax on the amount that sits above the allowance. For most graduates living in England, Wales, or Northern Ireland, the basic rate of Income Tax is 20 percent. This applies to earnings between £12,571 and £50,270. Scottish taxpayers have a different set of tax bands, starting with a 19 percent starter rate.

Once your salary moves past the basic rate band, you enter the higher rate tax bracket. For the 2025/2026 tax year, the higher rate is 40 percent, and this applies to any income you earn between £50,271 and £125,140. While most entry-level graduate roles will not push you into this bracket immediately, it is a target you might hit as you progress in your career. If your salary eventually exceeds £100,000, your Personal Allowance gradually decreases, meaning you pay tax on a larger portion of your income.

Your employer knows how much tax-free allowance to give you based on your tax code. The standard tax code for someone with one job and no untaxed income is 1257L. If your payslip shows a different code, such as BR or a code ending in W1 or M1, you might be on an emergency tax code. This often happens in your first graduate job if HMRC does not have your updated employment details. If you suspect an error, you should contact HMRC to get it corrected, and they will refund any overpaid tax in your next pay packet.

National Insurance Explained: Class 1 Contributions

While Income Tax funds general government spending, National Insurance is a specific tax that pays for state benefits, the NHS, and the State Pension. As an employee, you pay Class 1 National Insurance contributions.

Unlike Income Tax, which is calculated on your annual earnings, National Insurance is calculated on a per-pay-period basis. This means your NI deductions are worked out based on what you earn in a specific week or month.

According to GOV.UK (2025), you start paying Class 1 National Insurance when your earnings reach the Primary Threshold. For the 2025/2026 tax year, the rates are as follows:

Your National Insurance category letter determines the specific rate you pay. Most employees in the UK fall under category A. If you review your payslip, you should see this letter listed next to your National Insurance number. The system is designed to ensure that everyone contributes to the social security safety net. Your contributions build up your qualifying years, which eventually determine your eligibility for the State Pension. You need at least ten qualifying years to receive any State Pension, and thirty-five years to receive the maximum amount.

If your pay fluctuates because of overtime or bonuses, you might pay more National Insurance in some months than in others. Because NI is not cumulative over the year, you cannot usually claim a refund if you earn heavily in one month but fall below the threshold in another. Understanding these monthly deductions is essential when managing graduate money and setting up your first professional budget.

Worked Examples: Calculating Your PAYE Tax and NI

To make these concepts concrete, let us look at three practical worked examples. These calculations assume you are a standard taxpayer in England with the 1257L tax code for the 2025/2026 tax year.

Example 1: The Average Graduate Salary

Imagine you secure a marketing role paying £28,731 per year.

• Gross Monthly Pay: £28,731 divided by 12 equals £2,394.25.
• Income Tax: Your monthly tax-free allowance is £1,047.50. Your taxable pay is £2,394.25 minus £1,047.50, which leaves £1,346.75. At the 20 percent basic rate, your monthly Income Tax is £269.35.
• National Insurance: The monthly threshold is £1,048. You pay 8 percent on the earnings between £1,048 and £2,394.25. That is 8 percent of £1,346.25, which equals £107.70.
• Total Deductions: £269.35 (Tax) plus £107.70 (NI) equals £377.05.
• Net Take-Home Pay: £2,394.25 minus £377.05 equals £2,017.20 per month.

Example 2: A Corporate Graduate Scheme

Now imagine you join a finance graduate scheme with a starting salary of £35,000 per year.

• Gross Monthly Pay: £35,000 divided by 12 equals £2,916.67.
• Income Tax: Subtract your £1,047.50 tax-free allowance to get £1,869.17 in taxable pay. At 20 percent, your monthly Income Tax is £373.83.
• National Insurance: You pay 8 percent on earnings between £1,048 and £2,916.67. That is 8 percent of £1,868.67, which equals £149.49.
• Total Deductions: £373.83 (Tax) plus £149.49 (NI) equals £523.32.
• Net Take-Home Pay: £2,916.67 minus £523.32 equals £2,393.35 per month.

Example 3: A Part-Time Graduate Role

Perhaps you are working part-time while studying for a master’s degree, earning £18,000 per year.

• Gross Monthly Pay: £18,000 divided by 12 equals £1,500.
• Income Tax: Your taxable pay is £1,500 minus the £1,047.50 allowance, leaving £452.50. At 20 percent, your monthly Income Tax is £90.50.
• National Insurance: You pay 8 percent on earnings between £1,048 and £1,500. That is 8 percent of £452, which equals £36.16.
• Total Deductions: £90.50 (Tax) plus £36.16 (NI) equals £126.66.
• Net Take-Home Pay: £1,500 minus £126.66 equals £1,373.34 per month.

Working through these numbers helps demystify the figures on your payslip and allows you to plan your finances with accuracy.

Student Loan Repayments Alongside PAYE Tax and NI

Income Tax and National Insurance are not the only deductions you will see on your payslip. If you took out a student loan to fund your degree, your repayments will also be processed through the PAYE system.

Your student loan deductions happen automatically once your income exceeds the relevant repayment threshold. The threshold depends on which Plan you are on. For example, if you started your undergraduate degree in England on or after 1 August 2023, you are on Plan 5. The repayment threshold for Plan 5 is £25,000 a year. You will pay 9 percent of any income you earn above this threshold.

The repayment threshold varies significantly depending on when and where you studied. Graduates who started their courses between September 2012 and July 2023 in England or Wales are usually on Plan 2, which has a repayment threshold of £27,295 a year. Scottish students generally fall under Plan 4, which has a threshold of £31,395 a year. Regardless of your plan, the deduction mechanism remains identical. Your employer calculates 9 percent of your earnings above your specific threshold and sends it directly to the Student Loans Company.

Using the £28,731 salary from our first example on Plan 5, your student loan calculation would look like this:

• Your salary is £3,731 above the £25,000 annual threshold.
• You pay 9 percent of £3,731, which is £335.79 a year.
• This results in a monthly deduction of £27.98.

If you have multiple jobs or receive an annual bonus, your monthly pay might temporarily spike above the repayment threshold. In this case, a student loan deduction will be taken for that specific month. You can monitor your balance and repayment history by logging into your online account with the Student Loans Company. To project your long-term payoff timeline, try using our student loan calculator.

Checking Your Tax Code to Avoid Overpaying PAYE Tax

Your employer relies on HMRC to provide the correct tax code. If HMRC lacks the right information about your employment history, they will issue an emergency tax code. This usually happens if you start a new job and do not provide a P45 from a previous employer, or if this is your very first job and you have not completed a New Starter Checklist.

An emergency tax code assumes you have no tax-free allowance left for the year, meaning you will be taxed on all your income. This can result in hundreds of pounds being incorrectly deducted from your first few pay packets.

To prevent this, you should take the following steps:

1. Provide your employer with your P45 as soon as you accept the job offer.
2. If you do not have a P45, ask your HR department for a New Starter Checklist.
3. Check your first payslip immediately to verify that your tax code is 1257L.
4. Set up a personal tax account on the GOV.UK website so you can update your employment details directly.

At the end of every tax year, your employer will provide you with a P60 document. This summarises your total pay and deductions for the year. Keep this document safe, as you might need it to prove your income when renting a flat or applying for a mortgage. If you leave your job, your employer will give you a P45. This form shows how much tax you have paid so far in the current tax year. Handing your P45 to your new employer ensures your tax code transfers over smoothly, preventing any interruption to your Personal Allowance and keeping your PAYE tax accurate.

If you do overpay, HMRC will eventually adjust your tax code and refund the extra money through your payroll. However, being proactive ensures you get your full pay from day one. Taking control of your tax affairs early on is a great way to build confidence as you transition into graduate careers.