Pay As You Earn (PAYE): Definition and Examples

What Is Pay As You Earn (PAYE)?

Pay As You Earn (PAYE) refers either to a system of income tax withholding by employers or an income-based system for student loan repayments.

1. In the context of taxes, Pay As You Earn requires employers to deduct income tax—and in some cases the employee portion of social insurance benefit taxes—from each paycheck delivered to employees as a form of advance payment on taxes due.
2. In the context of student loans, PAYE is a U.S. federal loan repayment plan in which payment amounts are based on income rather than a fixed amount.

Understanding Pay As You Earn (PAYE)

The tax and revenue agencies of many countries employ the Pay As You Earn (PAYE) system, in which money is deducted from paychecks by the employer and remitted to the government with regular paychecks as they are earned.

Any sum taken in excess of the amount of tax due is repaid to the taxpayer. If there is a shortfall between how much tax was paid and how much was actually due, the taxpayer will have to make up the difference once they file their annual tax return document.

The PAYE system was originally developed in 1944 by Sir Paul Chambers in the United Kingdom. Such a system for collecting and paying taxes may also be referred to as "pay as you go," a term more prevalent in the United States.

PAYE in the UK and Other Countries

The pay as you earn system is a requirement in the United Kingdom for all salary earnings, as well as other forms of compensation if the earnings are expected to meet the National Insurance Lower Income Level. An employer will report sums collected for each payday using a Full Payment Submission (FPS) form to Her Majesty's Revenue and Customs (HMRC). Should an employee's work be terminated in the U.K., the employer will submit a Form P45 to the HRMC.

PAYE is also utilized in Ireland, New Zealand, and South Africa, among other countries. Many other countries use similar systems under different names, such as the Australian Tax Office's (ATO) "Pay As You Go Withholding (PAYGW)," withholding system, which was adopted in 1999.

PAYE and Student Loans

Pay As You Earn can be a helpful tool for individuals who have significant federal student loan debt but do not earn enough to meet their minimum payment without causing hardship. PAYE loan repayment is based on how much the borrower earns (an income-driven repayment plan).

Eligible federal student loan borrowers can have their monthly debt payment reduced to 10% of their discretionary income. After 20 years, any remaining balance is forgiven. PAYE is one of a number of payment assistance programs:

In addition to the PAYE scheme, there are also alternative student loan repayment plans, including the Revised Pay As You Earn Plan (REPAYE), an Income-Based Repayment Plan (IBR), and an Income-Contingent Repayment Plan (ICR Plan).

• Revised Pay-As-You-Earn Repayment Plan (REPAYE): Under this plan, your payments generally amount to 10% of your discretionary income and are due over a period of 20 years for undergraduate loans and 25 years for graduate school loans.
• Income-Based Repayment Plan (IBR): Payments are either 10% or 15% of your discretionary income and should not exceed your 10-year Standard Repayment Plan amount. The percentage depends on when you received the direct loan, as does the length of time you are required to make payments, which can be either 20 or 25 years.
• Income-Contingent Repayment Plan (ICR): With this option, your payments will be the lesser of 20% of your discretionary income or the amount you'd pay on a repayment plan with a fixed payment over 12 years, adjusted for your income. The repayment period with an ICR plan is 25 years.

The Bottom Line

Pay As You Earn is a term used in two primary ways: (1) as a means of taxation for income tax to be withheld by employers and (2) student loan repayments based on an income plan. The former is used in the U.K. and countries of the commonwealth while the latter applies to student loans in the United States.