Pre-tax deductions: A guide for HR and payroll managers

“Nothing is certain except death and taxes” is a famous quote by Benjamin Franklin, one of the Founding Fathers of America.

As HR and payroll managers, managing tax can be full of uncertainty. This is especially true of pre-tax deductions in the UK where laws and requirements are constantly changing.

In this article, we’re going to reduce this uncertainty.

Keep reading to learn what pre-tax deductions are, see some examples of payroll deductions, and discover how to manage them.

Here’s what we cover:

What is a pre-tax deduction?

A pre-tax deduction is money taken out of employees’ gross pay before income tax is calculated. They’re either required by British law, included in a contract or agreed in writing.

One important thing to note when working out how much tax is deducted from a salary is that any deduction must not leave employees’ pay below the National Minimum Wage.

There are two main types of pre-tax deductions:

• Statutory or involuntary, which you’re required to deduct from employees’ pay by law.
• Non-statutory tax deductions or voluntary, which aren’t legally required of employers. Instead, employers and employees agree in writing on which non-statutory pre-tax deductions should apply.

Examples of statutory pre-tax payroll deductions

If you’ve heard the question “how much tax is deducted from salary?” from your employees, there are number of deductions for them, and you, to take into consideration.

One to remember is on tax rates and thresholds—check HMRC’s website for the latest details.

Here’s a few more deductions to be aware of.

Income tax

The Pay As You Earn (PAYE) system ensures that income tax is collected evenly during the year.

When working out how much tax is deducted from a salary, it’s important to realise that there’s no one-size-fits-all formula.

Each employee’s deduction will be different, depending on their circumstances. For example, how much they earn (tax band) and their tax code.

Tax codes

Tax codes are made up of letters and numbers. They’re used to inform you of an employee’s tax-free allowance.

You must apply the right tax code to every employee, otherwise they can end up either paying too much tax or underpaying tax.

National Insurance contributions

National Insurance contributions (NICs) in the UK are used to fund government services, such as the State Pension and the NHS.

The amount of NICs you deduct from your employees’ pay varies according to how much they earn.

Employees who earn more than £242 per week will have Class 1 NICs deducted (unless they’re over the State Pension age, when they won’t pay National Insurance).

Pensions

Pension contributions can be deducted from employees’ gross pay (net pay arrangement) or after wages are taxed (relief at source).

By law, employers need to automatically enrol (known as auto-enrolment) employees who earn more than £10,000 per year and are aged between 22 and the UK State Pension age into a workplace pension scheme.

You need to deduct a certain percentage (normally around 5%) from employees’ pay to add to their pension pot.

Opting out of a workplace pension

Auto-enrolment in a UK workplace pension doesn’t mean that an employee has to continue with the pension scheme. They can opt-out by giving their employer an opt-out notice.

If the opt-out notice is received within one month of the employee starting work, they get a full refund of the pension contribution deducted by payroll.

If they opt-out after a month, their contributions stay in the pension pot until they retire.

Examples of non-statutory pre-tax deductions

Payroll giving

Employees in the UK can choose to donate money to a cause that’s close to their heart with payroll giving.

This tax-free donation is made through PAYE and is deducted from employees’ gross salary. The donation is sent directly to the charity.

Salary sacrifice

The salary sacrifice scheme is where an employee chooses to give up part of their gross pay to help pay for things like a bike or childcare.

You must check that your employees’ pay won’t fall below the National Minimum Wage after participating in the scheme.

Examples of salary sacrifice payroll deductions

Voluntary pension contributions

Employees in the UK have the option to top up their pensions by paying more into their pension fund.

If an employee chooses to make extra pension payments, you need to calculate the percentage and take the necessary deduction from their pay.

Workplace nursery scheme

Employees can use their deductions before tax to pay nursery fees.

After an employee chooses a nursery, you deduct the agreed amount from your employees’ pay and send it directly to the nursery.

Cycle to Work scheme

If an employee wants to commute to work by bike, they can take advantage of the UK’s Cycle to Work Scheme.

HR managers start by letting employees know about the cycle scheme providers the business has chosen. The payroll team then makes the necessary deductions for those employees who sign up and keeps the required records.

Techscheme

This salary sacrifice helps employees to buy tech, such as phones and laptops.

After the business registers with tech providers, the employee chooses the tech they need and signs the necessary agreements. The payroll team deducts the agreed amount from the employees’ pre-tax pay.

How to manage payroll deductions

To manage payroll deductions, you need to keep up to date with changes in the law and HMRC regulations.

HR managers must work with the legal department to draft contracts and agreements relating to different payroll deductions.

It’s important for HR teams to talk to employees about payroll deductions. Make it clear what the deductions are for and how long they will last.

The payroll team must set up their payroll software to handle the different pre-tax deductions and produce the necessary reports.

Final thoughts

As you now know, there are different types of pre-tax payroll deductions in the UK, each with their own rules.

However, they all have one thing in common: non-compliance can result in hefty penalties. Falling foul of pension requirements, for example, can result in fines, court action and even criminal charges.

On top of that, each employee could have a different level of payroll deductions. This might make working out how much tax to deduct from a salary even more complicated.

That’s why using reliable payroll software is a must, to ensure all employees have the correct amount of money deducted from their pay.

Managing payroll deductions correctly not only keeps your employees happy, it also provides protection against the serious consequences of failing to comply with the relevant laws and regulations.