Chapter 13: Payroll and Employees

Tax year notice: This guide uses 2025/26 tax year figures (6 April 2025 -- 5 April 2026). Check gov.uk for the latest rates.

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The hidden cost of hiring

When you decide to hire your first employee, the salary you agree is not the full cost. On top of every pound you pay in salary, the business pays employer National Insurance, pension contributions, and carries other costs the employee never sees.

Offering someone 30,000? Your actual cost is closer to 35,500. Understanding this gap is essential before you hire.

PAYE: How employer tax works

When you employ someone, you become responsible for deducting their tax and NI before paying them. This is the PAYE system you've been on the receiving end of since Chapter 2 -- now you're running it.

Your responsibilities as an employer:

• Register as an employer with HMRC
• Calculate and deduct income tax and employee NI from each payslip
• Pay employer NI on top of the salary (15% on earnings above 96/week)
• Report payroll to HMRC in real time (RTI -- Real Time Information) on or before each payday
• Pay the deductions to HMRC monthly (or quarterly if total deductions are under 1,500/month)
• Issue P60s to employees after the tax year end
• Handle statutory payments (sick pay, maternity pay, etc.)

Jargon Buster: RTI (Real Time Information) The system where you report payroll information to HMRC every time you pay an employee, on or before the payment date. This replaced the old system of reporting once a year. Your payroll software handles the submission.

Employer NI: The tax you pay

Employer NI is 15% on all earnings above 96 per week (approximately 5,000/year). Unlike employee NI, there's no upper limit -- it's 15% all the way up.

This is a significant cost. On a 30,000 salary:

• Employee earns above the threshold: 30,000 - 5,000 = 25,000
• Employer NI: 25,000 x 15% = 3,750

That's money the employee never sees and the business must budget for.

Employee salary	Employer NI (15%)	Pension (3%)	Total cost to business
20,000	2,250	600	22,850
25,000	3,000	750	28,750
30,000	3,750	900	34,650
35,000	4,500	1,050	40,550
40,000	5,250	1,200	46,450
50,000	6,750	1,500	58,250

Employer NI calculated on earnings above approximately 5,000/year. Pension at 3% minimum employer contribution. Does not include other costs like holiday pay accrual, equipment, training, or insurance.

Auto-enrolment pensions

As an employer, you must automatically enrol eligible employees into a workplace pension scheme. This is the same auto-enrolment from Chapter 4, but now you're the one running it.

Who you must enrol:

• Employees aged 22 to State Pension age
• Earning over 10,000 per year
• Working in the UK

Minimum contributions:

Who	Minimum
Employer	3% of qualifying earnings
Employee	5% of qualifying earnings
Total	8%

Qualifying earnings are the portion between 6,240 and 50,270. On a 30,000 salary, qualifying earnings are 23,760. Employer minimum: 712.80/year. Employee minimum: 1,188/year.

You must choose a pension provider, set up the scheme, and manage enrolments. Most payroll software integrates with pension providers to automate contributions.

Employees can opt out after being enrolled, but you must re-enrol them every 3 years. You cannot encourage or incentivise opting out.

Director salary optimisation

If you're a director of your own company (from Chapter 12), you need to run payroll for yourself. The optimal salary level is a strategic decision:

Option 1: Salary at 12,570 (Personal Allowance)

• No income tax (within Personal Allowance)
• Some employer NI payable (on the amount above 5,000 threshold)
• Counts as a qualifying year for State Pension
• Remaining profit taken as dividends (lower tax)

Option 2: Salary at the NI Primary Threshold (~12,570)

• No income tax, no employee NI
• Small amount of employer NI
• Still qualifies for State Pension
• Most tax-efficient for many director-shareholders

Option 3: Higher salary (e.g., 50,270)

• Uses the full Basic Rate band
• Higher employer NI cost (but employer NI is a deductible business expense)
• Better for pension contributions and mortgage applications
• Run the numbers carefully -- often less efficient overall

Most accountants recommend Option 2 for single-director companies. The exact optimal number changes slightly each year as thresholds shift.

Statutory payments

As an employer, you may need to pay statutory amounts for:

Payment	Rate	Duration
Statutory Sick Pay (SSP)	116.75/week	Up to 28 weeks
Statutory Maternity Pay (SMP)	90% of salary for 6 weeks, then 184.03/week for 33 weeks	39 weeks
Statutory Paternity Pay (SPP)	184.03/week	2 weeks
Statutory Shared Parental Pay (ShPP)	184.03/week	Up to 37 weeks (shared)

You can reclaim some statutory payments from HMRC (92% of SMP, or 103% if your NI liability is small). Your payroll software calculates this.

Hiring your first employee: Step by step

1. Decide the role and salary -- Include employer NI and pension in your budget calculation
2. Register as an employer with HMRC at gov.uk/register-as-an-employer (takes up to 5 working days to get your PAYE reference)
3. Get employer's liability insurance -- Legal requirement as soon as you employ anyone (minimum 5 million coverage). Fines of 2,500/day for not having it.
4. Choose a pension provider -- NEST (nestpensions.org.uk) is the government-backed option, free to set up
5. Set up payroll software -- Either use your accounting software's payroll module or standalone payroll software
6. Check the employee's right to work -- Legal requirement. Keep copies of documents.
7. Issue a written statement of employment -- Required from day one. Must include pay, hours, holiday entitlement, notice period.
8. Run first payroll -- Deduct tax and NI, report via RTI, pay the employee
9. Set up pension contributions -- Enrol the employee and begin deductions

Subcontractors vs employees

Before hiring an employee, consider whether you actually need one -- or whether a subcontractor would work.

Factor	Employee	Subcontractor
Control	You control how and when they work	They control how they deliver the work
Tax	You handle PAYE, NI, pension	They handle their own tax (sole trader or Ltd)
Cost	Salary + employer NI + pension + holiday pay	Their invoice (usually higher day rate but no extras)
Flexibility	Ongoing commitment, notice periods	Project-by-project, easier to scale up/down
Rights	Entitled to holiday, sick pay, redundancy	No employment rights
Risk	HMRC can investigate IR35/off-payroll status	Same risk -- misclassification can be costly

Warning: IR35/Off-payroll working rules. If HMRC decides that a subcontractor is actually an employee in disguise (same hours, same desk, same boss, only one client), they can reclassify the relationship and charge back taxes plus penalties. If you're using a subcontractor who works like an employee, you're at risk.

Steve is thinking about whether to hire a helper or use subcontractors for big jobs. For occasional help on large projects, subcontractors make more sense. For regular daily work, an employee provides reliability and is legally cleaner.

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Real Scenario: Sam hires a warehouse assistant

Sam's Vintage Ltd has grown to the point where Sam can't handle packing, posting, and sourcing alone. Sam hires Alex as a part-time warehouse assistant at 15,000/year (20 hours/week).

Cost to Sam's Vintage Ltd:

Item	Annual cost
Salary	15,000
Employer NI (15% above 5,000)	1,500
Pension (3% of qualifying earnings)	262.80
Employer's liability insurance	150
Total employment cost	16,912.80

The 15,000 salary costs the company 16,912.80 -- 12.8% more than the headline figure.

Alex takes home: 15,000 - income tax (486) - employee NI (194) - pension 5% (438) = 13,882 net pay.

Real Scenario: Steve hires his first gardener

Steve's business is turning over 78,000 with more demand than he can handle alone. He hires Jordan as a full-time gardener at 24,000/year.

Cost to Steve:

Item	Annual cost
Salary	24,000
Employer NI (15% above 5,000)	2,850
Pension (3% of qualifying earnings)	532.80
Employer's liability insurance	280
Van insurance (additional driver)	400
Tools and PPE	300
Total employment cost	28,362.80

Steve needs Jordan to generate at least 28,363 in additional revenue just to break even on the hire. With a helper, Steve can take on 2--3 additional clients per day. At average 80/visit, that's 160--240/day extra. Jordan pays for himself within weeks.

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Checklist: Hiring your first employee

• Budget the full cost: salary + employer NI (15%) + pension (3%) + insurance
• Register as an employer with HMRC (allow 5 working days)
• Get employer's liability insurance (legal requirement from day one)
• Choose and set up a pension scheme (NEST is free to set up)
• Set up payroll software (many accounting packages include payroll)
• Create a written statement of employment (terms, hours, pay, holiday)
• Check the employee's right to work in the UK (keep copies)
• Run payroll: calculate deductions, report to HMRC via RTI, pay the employee
• Enrol the employee in the pension scheme
• Pay HMRC the tax and NI deductions by the 22nd of the following month

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Jargon Buster

Term	Plain English
PAYE	Pay As You Earn -- the system where employers deduct tax and NI from wages before paying employees
Employer NI	National Insurance the employer pays on top of the salary (15% above approximately 5,000/year). The employee never sees this cost.
RTI (Real Time Information)	Reporting payroll details to HMRC each time you pay an employee
Auto-enrolment	The legal requirement to put eligible employees into a workplace pension
Qualifying earnings	The portion of salary between 6,240 and 50,270 that pension contributions are calculated on
Employer's liability insurance	Compulsory insurance covering claims from employees injured or made ill through work. Minimum 5 million coverage.
Statutory Sick Pay (SSP)	The minimum amount an employer must pay employees who are off sick
P45	A form an employee gets when they leave a job, showing pay and tax for the year so far. Given to the next employer.
P60	Annual summary of pay and deductions, given to each employee by 31 May
IR35	Rules to determine whether a contractor is really an employee for tax purposes
NEST	National Employment Savings Trust -- a government-backed pension scheme free for employers to set up
FPS (Full Payment Submission)	The payroll report sent to HMRC via RTI each time you pay employees