Xero Payroll Setup: PAYE and RTI Configuration Guide

Xero payroll setup requires accurate PAYE details, employee records, pay calendars, opening balances and workplace pension settings before the first live pay run is processed. Completing these steps in the correct order helps Xero calculate deductions properly, submit Real Time Information to HMRC and post reliable payroll figures into the accounts.

The setup is particularly important when a business moves to Xero during the tax year. Previous pay, Income Tax, National Insurance, statutory payments and other year-to-date figures must be transferred accurately so later payslips and payroll reports remain complete.

This guide explains the principal Xero Payroll configuration steps for a UK employer. Payroll and employment rules can depend on individual circumstances, so specialist advice may be required where an employee has unusual pay, benefits, statutory leave or employment arrangements.

What Xero payroll setup includes

Xero payroll setup begins with the organisation-level information used across every employee and pay run. This includes the PAYE scheme details, payroll accounts, bank account, pay calendars, earnings categories, deductions and workplace pension arrangements.

Each employee then needs an individual record containing their personal details, employment information, tax code, National Insurance category, pay template and pension status.

Businesses moving from another payroll system must also enter opening balances before processing the first Xero pay run. Xero advises that payroll opening balances cannot be updated once a pay run has been created, so they should be checked carefully beforehand.

Xero’s official UK payroll setup guidance explains the organisation-level configuration process.

Register with HMRC before using Xero Payroll

A new employer normally needs to register with HMRC before its first payday. HMRC then issues an employer PAYE reference and Accounts Office reference.

These references are separate and serve different purposes. The PAYE reference identifies the employer’s payroll scheme, while the Accounts Office reference is used when making PAYE payments and allocating them to the correct account.

The references should be copied exactly from HMRC correspondence. Entering incorrect details can cause RTI submissions to be declined or payments to be allocated incorrectly.

HMRC’s employer registration guidance explains when registration is required and how to apply.

Prepare the information needed for Xero payroll setup

Before opening the payroll configuration screens, gather the employer references, Government Gateway credentials, employee starter information, pension scheme details and previous payroll reports where relevant.

For an established payroll moving during the tax year, obtain the most recent payroll summary, employee year-to-date records, previous Full Payment Submissions and any Employer Payment Summary information affecting the PAYE liability.

You may also need information about Employment Allowance, statutory-payment recovery, student loans, attachment orders and benefits being processed through payroll.

Preparing this information first reduces the risk of beginning a pay run with incomplete opening figures.

Configure the payroll accounts

Xero needs suitable general-ledger accounts for wages, employer costs and payroll liabilities.

The setup normally identifies the bank account used to pay employees and accounts for wages, employer National Insurance, pension costs, PAYE liabilities and employee reimbursements.

The account choices affect the payroll journal posted into the bookkeeping records. They should therefore be reviewed rather than accepted without considering the existing chart of accounts.

A clear structure makes it easier to reconcile net wages, HMRC payments and pension contributions after each pay run.

Add the employer PAYE details

Enter the employer PAYE reference, Accounts Office reference and the credentials required for RTI filing within the Xero payroll settings.

The legal organisation name and PAYE scheme details should agree with HMRC’s records. Differences in references, spaces or characters can prevent a successful submission.

The business should also confirm which person is authorised to submit payroll information and who will investigate declined filings.

Xero’s payroll preparation guidance identifies the information required before payroll is configured.

Create the correct pay calendars

A pay calendar defines how often employees are paid and the dates covered by each pay period.

Separate calendars may be needed for weekly, fortnightly, four-weekly and monthly employees. Staff should be assigned to the calendar matching their employment arrangements.

The payment date is particularly important because it determines the tax period and the deadline for the Full Payment Submission.

HMRC generally requires an FPS on or before the date employees are paid. The business should therefore establish a payroll timetable that allows sufficient time for information collection, review and approval before payday.

Set up payroll earnings and deductions

Xero uses pay items to represent salary, ordinary hours, overtime, bonuses, commissions, allowances, reimbursements and other elements of employee pay.

Deductions may include workplace pension contributions, student loans, attachment orders, salary advances and other authorised amounts.

Each item should have the correct tax, National Insurance and pension treatment. Creating a generic payment category for several unrelated types of pay can lead to incorrect deductions and less useful payroll reports.

Regular items can be added to an employee’s pay template, while occasional payments can be entered during the relevant pay run.

Add employees to Xero Payroll

Each employee record should include the employee’s full legal name, address, date of birth, start date and National Insurance number where available.

The record also needs employment details, pay frequency, tax information, National Insurance category and payment method.

Incorrect personal information can create duplicate or inaccurate HMRC employment records. The employee’s name should normally match the name used on official documents.

Xero’s employee setup guidance explains the information and payroll settings available within each record.

Enter the employee’s starter information

A new employee should normally provide a P45 from their previous employment. Where no P45 is available, the employee should complete HMRC’s starter checklist.

The information determines the initial tax-code basis and whether previous pay and tax are included.

The employer should not guess the starter declaration or tax code. Using incorrect starter information can result in too much or too little Income Tax being deducted.

Where HMRC later issues a tax-code notice, the authorised code should be applied through payroll.

Check tax codes and National Insurance categories

The tax code controls the PAYE Income Tax calculation. The National Insurance category affects the employee and employer contribution calculations.

Category A applies to many employees, but different categories can apply to apprentices, younger workers, employees over State Pension age and other qualifying groups.

The category should be based on the employee’s actual circumstances and supporting evidence rather than selected solely to reduce the payroll cost.

Xero can process the calculations, but the result will be incorrect where the underlying code or category has been entered wrongly.

Create employee pay templates

The pay template contains the employee’s regular salary, hours, deductions, pension settings and other recurring payroll items.

A salaried employee may have a fixed monthly earnings item, while an hourly employee may require ordinary hours and changing quantities during each pay run.

The template should include only amounts that recur. Bonuses, irregular overtime and one-off reimbursements can normally be added when they arise.

Before the first payroll is posted, compare the template with the employment contract or authorised pay information.

Enter employee opening balances

When payroll moves to Xero partway through a tax year, each employee’s year-to-date balances must be entered.

These can include gross pay, taxable pay, Income Tax, National Insurance, student loans, pension deductions and statutory payments already processed.

The balances should agree with reports from the previous payroll system and the most recent payslips.

Incorrect opening balances affect later year-to-date figures, P60 information and HMRC reporting. Xero confirms that opening balances should be entered before the first pay run is created.

Enter organisation-level payroll opening balances

The employer may also have year-to-date balances that are not held solely within individual employee records.

These can include statutory-payment recovery and any remaining Employment Allowance available for the tax year.

The figures may need to be taken from the final Employer Payment Summary or payroll reports produced by the previous system.

The opening balances should be reviewed with the existing PAYE account so Xero does not duplicate relief already claimed or omit amounts carried forward.

Configure workplace pensions

An employer’s automatic-enrolment duties generally begin when its first employee starts work.

The employer must assess its workers and automatically enrol eligible employees into a qualifying workplace pension scheme. It must also maintain records and make the required contributions.

Within Xero, the pension scheme should be configured with the provider, scheme details, contribution basis and employee and employer rates.

Xero then creates the relevant pension pay items and uses them during pay runs. Its workplace pension setup guidance explains the available configuration options.

Check the pension calculation basis

Pension contributions may be calculated using qualifying earnings, pensionable pay or another permitted basis associated with the scheme.

The Xero settings must correspond with the pension provider’s scheme rules. Using the wrong basis can produce contributions that disagree with the provider’s records.

Salary sacrifice arrangements also need careful configuration because they affect contractual pay, tax, National Insurance and pension reporting.

The employer should confirm the scheme basis with the pension provider rather than selecting a setting from memory.

Assign employees to the pension scheme

Employees should be assessed and assigned according to their automatic-enrolment status.

The employer may need to record enrolment dates, postponement, opt-in requests or valid opt-out information.

An employee should not simply be removed from the pension calculation because they ask the employer informally. Opt-outs must follow the permitted process and timescale.

The Pensions Regulator’s automatic-enrolment guidance for new employers explains the continuing duties that apply from the first employee’s start date.

Set up statutory payments

Xero Payroll can process statutory payments where the employee meets the relevant conditions and the employer enters the necessary dates and information.

These can include Statutory Sick Pay and qualifying family-related payments.

The employer remains responsible for maintaining absence records and obtaining the evidence required for each claim.

Where the employee also receives contractual sick or family leave pay, the pay template and statutory item should be configured so the employee is not paid twice unintentionally.

Add student loans and attachment orders

Student and postgraduate loan deductions should be added where HMRC instructs the employer or the employee’s starter information requires them.

The correct loan plan matters because different deduction thresholds can apply.

Attachment orders should be entered from the official notice, including any protected earnings amount and administration charge permitted.

The complete documentation should be retained and the deduction checked during the first affected pay run.

Configure payslips and employee access

Xero can provide electronic payslips through email or Xero Me access, depending on the organisation’s configuration.

The employer should check which information appears on the payslip, including earnings, deductions, pension contributions and leave balances.

Employees should have secure individual access rather than receiving another employee’s information or using a shared login.

Xero’s payslip guidance explains how payslips can be configured and supplied.

Review the first Xero pay run

The first pay run should be reviewed line by line before it is posted.

Check each employee’s gross pay, tax code, PAYE deduction, National Insurance, pension contribution, student loan and net pay.

Compare salaried pay with the employment records and variable pay with authorised timesheets or schedules.

Reviewing the calculations before submission is considerably easier than correcting an inaccurate FPS and reimbursing an employee after payday.

Submit the Full Payment Submission

The FPS reports employee pay, deductions, starters, leavers and other payroll information to HMRC.

It should normally be submitted on or before payday. HMRC requires an FPS each time employees are paid, subject to limited exceptions.

Xero records RTI filings within the payroll area. The submission status should be checked rather than assuming that posting the pay run guarantees HMRC acceptance.

HMRC’s running payroll guidance explains the regular PAYE tasks and FPS deadline.

Check for accepted or declined RTI filings

An RTI submission can be accepted, declined or remain pending while it is processed.

A declined filing should be investigated promptly. Common causes can include incorrect PAYE details, invalid employee information or an HMRC authorisation issue.

The employer should not repeatedly resubmit unchanged information without understanding the rejection.

Xero’s declined RTI guidance explains how errors can be reviewed and corrected.

Use Employer Payment Summaries correctly

An Employer Payment Summary reports information not included within the ordinary FPS.

It may be used to report statutory-payment recovery, claim Employment Allowance or tell HMRC that no employees were paid during a tax month.

Where no FPS is due because nobody was paid, HMRC generally expects the no-payment information by the nineteenth day after the relevant tax month.

Xero’s HMRC payroll filing guidance explains how FPS and EPS information is managed in the software.

Review the PAYE liability

After the pay run, review the amount due to HMRC for Income Tax, employee National Insurance, employer National Insurance and other deductions.

The figure should be adjusted for valid Employment Allowance and statutory-payment recovery reported through the EPS.

The amount shown by Xero should be compared with the PAYE control account and the employer’s HMRC online account.

HMRC payments are made outside Xero. The payment should use the correct Accounts Office reference and reach HMRC by the applicable deadline.

Post and review the payroll journal

When the pay run is posted, Xero creates the related payroll journal using the accounts selected during setup.

The journal should record gross pay, employee deductions, employer National Insurance, employer pension contributions, net wages and liabilities separately.

Net wage payments should then be reconciled against the payroll liability rather than recorded as new wage expenses.

Payments to HMRC and the pension provider should reduce their respective liability accounts.

Reconcile payroll after each pay run

The payroll reports, accounting journal and bank payments should agree.

Net pay should match the total transferred to employees. The PAYE liability should agree with payroll reports after valid adjustments.

Pension deductions and employer contributions should agree with the contribution schedule supplied to the pension provider.

Regular reconciliation helps identify missing payments, duplicated journals and liabilities that were posted to the wrong period.

Correct payroll errors through payroll

An incorrect employee payment or deduction should be corrected within the payroll records and reported to HMRC where required.

Changing only the bookkeeping journal or bank payment does not correct the employee’s payroll history.

Xero can use an unscheduled pay run for certain adjustments. The correct method depends on the type of error and whether it relates to the current or an earlier tax year.

Material overpayments, underpayments or minimum-wage concerns may also require employment-law advice.

Common Xero payroll setup mistakes

A common mistake is processing the first pay run before entering employee and employer opening balances.

Other errors include using the wrong PAYE reference, assigning an incorrect National Insurance category, selecting the wrong pension basis and creating inaccurate pay calendars.

Employers may also post net wage payments directly to the wages expense account, leaving the payroll journal liabilities unreconciled.

Each error becomes more difficult to correct after several pay runs, so the complete setup should be reviewed before the first FPS is filed.

Xero payroll setup for company directors

Company directors are subject to PAYE but have specific National Insurance calculation rules based on an annual earnings period.

The employee record should identify the individual as a director and include the correct appointment date and calculation method.

Processing a director as an ordinary employee can produce an incorrect National Insurance pattern.

Our guide to director salary and dividends explains why salary must be processed through payroll while dividends require separate company records and sufficient distributable profit.

Combining Xero Payroll with bookkeeping

Managing payroll and bookkeeping together can make monthly reconciliation more efficient.

The payroll journal can be reviewed promptly, while employee payments, PAYE and pension contributions are matched against the correct liabilities.

Bookkeeping Packages Ltd provides outsourced payroll services that can include PAYE calculations, RTI filings, payslips and payroll record maintenance.

Our wider Xero bookkeeping service can combine payroll with transaction processing, reconciliation, VAT and monthly reporting.

Getting help with Xero payroll setup

The first step is to review the PAYE scheme, employee records, pension arrangements and current payroll reports.

For a mid-year transfer, the previous system’s year-to-date balances and final submissions should be checked before any Xero pay run is created.

We can then configure the payroll settings, employee records, pay calendars and accounting links according to the agreed service.

To discuss Xero payroll setup or ongoing processing, use the Bookkeeping Packages enquiry form or call 0161 531 0087.

About the Author

Stuart Kerr is Managing Director of Bookkeeping Packages Ltd, an outsourced bookkeeping service supporting UK small businesses and accountancy practices. With over 20 years of bookkeeping experience, Stuart specialises in helping businesses maintain reliable financial records and useful management information.

This article is provided for general information only. Stuart Kerr is a professional bookkeeper, not an employment lawyer, tax adviser or regulated financial adviser. Nothing in this article constitutes tax, legal, employment or financial advice. Advice specific to your circumstances should be obtained from an appropriately qualified professional.