Pay As You Earn (PAYE): Definition and Examples 

By
Adam Hayes
Full Bio

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

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Updated June 12, 2021
Reviewed by Margaret James
Pay As You Earn (PAYE)

Investopedia / Joules Garcia

What Is Pay As You Earn?

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.

Key Takeaways

  • Pay as you earn (PAYE) refers to a repayment or withholding scheme that incrementally makes deductions as paychecks are received.
  • For income tax withholding, employees that elect automatic withholding see pre-payments made to federal and/or state taxing authorities with each paycheck. Those who over-withhold get a tax refund at the end of the year.
  • In reference to student loans, PAYE  takes out 10% of discretionary income as it is earned, and generally lasts up to 20 years.

Pay As You Earn Explained

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 it 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.

Pay As You Earn in Use

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

Pay As You Earn 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 (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 be 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.