Hiring your first employee through your limited company

Initial Decisions and The True Cost of an Employee

Before you can hire, your first decision is financial: how much can the company afford to pay? This is more than just the headline salary. The 'true cost' of an employee includes the gross salary plus mandatory on-costs: Employer's National Insurance Contributions (NICs) and minimum employer pension contributions. For the 2025/26 tax year, Employer's NICs are 15% on all earnings above the annual Secondary Threshold of £5,000. Additionally, you must contribute a minimum of 3% of the employee's qualifying earnings into a workplace pension. These additions can increase the total cost by 20% or more over the basic salary, a crucial calculation for your business plan and cash flow forecasts. Factoring these non-negotiable costs in from the start prevents financial surprises later.

Your next key decision is the individual's employment status. Most first hires will be 'employees', granting them the full suite of employment rights like statutory sick pay and protection against unfair dismissal after a qualifying period. Alternatively, you might engage a 'worker' or a self-employed 'contractor'. Workers have fewer rights than employees but are still entitled to minimum wage and paid holiday. Contractors are in business for themselves and are responsible for their own tax. Misclassifying an employee as a contractor to avoid employer obligations is a serious compliance breach with significant financial risk. For a first hire who will be integral to your operations, the 'employee' route is typically the correct and safest legal path. Always seek advice if you are unsure, as the determination rests on the reality of the working relationship.

Worth knowing: The total cost of an employee significantly exceeds their gross salary due to mandatory employer contributions for National Insurance and pensions.

Essential Legal and HMRC Setup

Once you have decided to hire, two immediate legal obligations must be met before your employee starts. First, you must take out an Employers’ Liability (EL) insurance policy from an authorised insurer. This is a legal requirement for almost every limited company with employees. The policy must cover you for at least £5 million and you must display the certificate of insurance where employees can easily read it. Failing to have adequate EL insurance can result in a fine of £2,500 for every day you are not properly insured. Second, you must check if the candidate has the legal right to work in the UK. You must check and take copies of specific original documents before their employment begins. Failure to do so can lead to a civil penalty of up to £60,000 per illegal worker.

With insurance and right-to-work checks completed, your company must register with HM Revenue & Customs (HMRC) as an employer. This process sets you up for Pay As You Earn (PAYE), the system used to collect Income Tax and National Insurance from employee pay. You must register before the first payday; do not wait until after you have paid them. The registration can be done online through the GOV.UK website and can take up to 5 working days to receive your employer PAYE reference number, which you will need for running payroll. It's wise to complete this registration as soon as you have a firm start date for your employee to avoid any last-minute delays that could affect their first salary payment.

1. 1

   Decide on your employee's start date and salary.

2. 2

   Obtain Employers' Liability insurance with at least £5 million of cover.

3. 3

   Perform a right-to-work check on your prospective employee.

4. 4

   Register as an employer with HMRC online, at least 5 working days before the first payday.

5. 5

   Receive your PAYE and Accounts Office reference numbers from HMRC by post.

6. 6

   Choose payroll software to record employee details and calculate pay and deductions.

The Employment Contract: Getting It in Writing

While a formal, signed document is best practice, a legally binding employment contract exists from the moment an offer of employment is accepted. However, by law, you must provide an employee with a 'written statement of employment particulars' on or before their first day of work. This document outlines the main terms of their employment. Failing to provide this statement, or providing an incomplete one, can leave your company vulnerable in an employment tribunal. It is a foundational document that clarifies expectations for both parties and minimises the risk of future disputes. For your first hire, using a template from a reputable legal source and customising it is a sensible approach, but for complex roles, seeking legal advice is recommended.

The written statement must contain specific information, known as the 'principal statement'. This includes your company name, the employee's name, job title, start date, salary details, and working hours. It also needs to specify terms related to holiday entitlement, sick pay, notice periods, and place of work. Other details about pensions, disciplinary procedures, and grievance processes can be provided in a separate, accessible document like a staff handbook, but the principal statement must refer to them. It's good practice to include additional clauses covering confidentiality, data protection, and intellectual property, especially if the employee will be handling sensitive company information or creating original work. This ensures your company's assets are protected from the outset.

• Names of the employer and employee
• Start date and any previous continuous employment
• Job title or a brief description of the work
• Place of work (and if they must work in various locations)
• Salary (how much and how often it will be paid)
• Hours of work (including details on normal working hours)
• Holiday entitlement and holiday pay
• Sick leave and sick pay arrangements
• Notice periods required from both employer and employee
• Pension information
• Details of any disciplinary and grievance procedures

Worth knowing: You are legally required to provide your employee with a written statement of key employment terms by their first day of work.

Running Payroll: PAYE, NICs and Pensions

Running payroll is a critical monthly (or weekly) task. Your company acts as a tax collector for HMRC through the Pay As You Earn (PAYE) system. Using payroll software, you calculate how much Income Tax and National Insurance to deduct from your employee's gross pay. The software uses the employee's tax code, issued by HMRC, to determine their tax-free personal allowance. For the 2025/26 tax year, the standard personal allowance is £12,570. In England, Wales and Northern Ireland, earnings above this are taxed at 20% (basic rate), 40% (higher rate), and 45% (additional rate). Note that Scotland has different income tax bands and rates which your payroll software must account for if your employee is a Scottish taxpayer. These deductions are then paid to HMRC by your company.

Alongside Income Tax, you must manage National Insurance Contributions (NICs). There are two main types. Employee's (Primary) Class 1 NICs are deducted from their salary. For 2025/26, this is typically 8% on earnings between the Primary Threshold (£12,570) and the Upper Earnings Limit, and 2% on earnings above that. Separately, your company pays Employer's (Secondary) Class 1 NICs. As of April 2025, this is charged at a rate of 15% on all earnings the employee receives above the Secondary Threshold of £5,000 per year. This is a direct cost to your business, over and above the employee's salary. Both employee and employer contributions are calculated by your payroll software and reported to HMRC.

Finally, payroll is where you administer workplace pension contributions. Under auto-enrolment law, you must contribute to your employee's pension, and so must they (unless they opt out). For 2025/26, the minimum total contribution is 8% of their 'qualifying earnings', which are earnings between a lower and upper threshold (currently £6,240 and £50,270 per year). Of this 8%, you as the employer must pay at least 3%. The employee contributes the remaining 5%, which is deducted from their pay after tax has been calculated (as pension contributions receive tax relief). Your payroll software handles these calculations and deductions, ensuring you meet your legal obligations.

Understanding and Claiming the Employment Allowance

The Employment Allowance is a significant tax relief that allows eligible employers to reduce their annual Employer's National Insurance liability. For the 2025/26 tax year, the allowance is set at a generous £10,500. This means you can pay £10,500 less in Employer's NICs over the tax year. For a company hiring its first employee, this could completely eliminate your employer NICs bill, substantially reducing the cost of employment. You claim the allowance through your payroll software when you send your first Full Payment Submission (FPS) of the tax year to HMRC. The software will automatically offset your accumulating employer NICs liability each pay period until the £10,500 allowance is fully used up.

Crucially, not all companies are eligible. The most significant exclusion for small businesses is that the allowance cannot be claimed by a company where the only employee paid above the Secondary Threshold (£5,000) is a director. This is known as a 'single-director company'. Therefore, if you are the sole director and only employee, you cannot claim it. However, as soon as you hire your first non-director employee, your company becomes eligible, provided your total employer NICs liability in the previous tax year was below the specified limit (currently £100,000). For a new employer, this previous year's liability will be nil, so you will qualify on that basis. This makes the allowance a powerful incentive for director-led companies to create their first job for someone else.

Worth knowing: The £10,500 Employment Allowance can eliminate the Employer's NICs bill for most small companies, but not for single-director companies.

Workplace Pensions and Auto-Enrolment

As an employer, you have a legal duty to automatically enrol eligible staff into a workplace pension scheme and make contributions towards it. This duty begins on the day your first employee starts working for you, known as your 'duties start date'. You must assess your employee to see if they meet the criteria for auto-enrolment: aged between 22 and the State Pension age, and earning over £10,000 a year. If they meet these criteria, enrolment is mandatory, although the employee retains the right to opt out. The Pensions Regulator oversees this regime and can issue substantial fines for non-compliance, starting with a £400 fixed penalty and escalating daily penalties. This is not an optional task; it is a fundamental director's responsibility.

The first step is to choose a pension scheme. There are several large providers who cater for small businesses, including government-backed schemes. You should do this ahead of your employee's start date as it can take time to set up an account. Once the scheme is live and your employee has started, you must formally write to them within six weeks to explain how auto-enrolment affects them. You will then need to calculate and deduct contributions via your payroll each month, paying them over to the pension provider. Finally, you must complete a 'declaration of compliance' with The Pensions Regulator within five months of your duties start date to confirm you have fulfilled your obligations. Managing pensions is an ongoing duty for as long as you have employees.

• **NEST (National Employment Savings Trust):** A government-backed scheme that is legally required to accept all employers.
• **The People's Pension:** A large master trust scheme popular with small and medium-sized businesses.
• **Smart Pension:** A technology-focused provider known for its quick online setup.
• **NOW: Pensions:** Another major provider in the auto-enrolment market.
• Consult a financial adviser for more complex needs or a wider choice of providers.

Worth knowing: Setting up a workplace pension and enrolling your employee is a legal duty that starts from their first day of employment.

Statutory Leave and Pay Entitlements

All employees have a statutory right to paid time off. The legal minimum is 5.6 weeks of paid holiday per year, which for a full-time employee working five days a week equates to 28 days. This can include bank holidays. You must have a clear policy on how holiday is accrued, booked, and what happens to untaken leave when employment ends. Part-time employees are entitled to the same amount of holiday on a pro-rata basis. It is your responsibility to ensure employees are able to take their holiday, and you must pay them their normal rate of pay during this leave. Keeping accurate records of holiday taken is essential for compliance and for calculating the final pay packet if the employee leaves.

If an employee is too ill to work, they may be entitled to Statutory Sick Pay (SSP). To qualify, they must be off work for at least four days in a row (including non-working days), be classed as an employee, and earn on average at least the Lower Earnings Limit. SSP is paid at a flat weekly rate set by the government for up to 28 weeks. While you can choose to offer more generous company sick pay in the employment contract, you cannot pay less than the statutory minimum. As an employer, you are responsible for paying SSP, but for small companies, it is a direct cost as schemes to reclaim it have largely ended.

Employees also have rights to time off and pay for family-related reasons. These include Statutory Maternity Leave (up to 52 weeks) and Pay (up to 39 weeks), Paternity Leave and Pay, Adoption Leave and Pay, and Shared Parental Leave. The rules for eligibility and payment rates are complex and vary for each type of leave. For example, to qualify for Statutory Maternity Pay, an employee must meet certain continuous employment and earnings criteria. While your company pays the employee, you can usually reclaim 92% or 103% of the cost from HMRC, depending on the size of your business. Understanding these rights is crucial for managing your workforce legally and compassionately.

Health, Safety, and Data Protection Duties

As an employer, you have a legal 'duty of care' for your employees' health, safety, and welfare at work. This applies regardless of your company's size or industry. For a low-risk office environment, this might involve ensuring workstations are set up correctly to avoid back pain (Display Screen Equipment regulations), keeping the workplace free of hazards, and having a first-aid kit. You are required to have a health and safety policy, though if you have fewer than five employees, it does not need to be written down. However, writing it down is good practice. If your employee works from home, your duty of care extends to their home workspace. You must ensure it is a safe environment, which usually involves a homeworking risk assessment. These responsibilities are enforced by the Health and Safety Executive (HSE).

When you hire an employee, you will be collecting, storing, and processing their personal data, such as their address, bank details, and health information. This activity means you must comply with the UK General Data Protection Regulation (UK GDPR). You have a legal obligation to handle this data securely, use it only for legitimate employment purposes, and not keep it for longer than necessary. You must also provide your employee with a privacy notice explaining what data you hold, why you hold it, and who it might be shared with (e.g., your pension provider or HMRC). Because you are processing personal data, your limited company will almost certainly need to register with the Information Commissioner's Office (ICO) and pay an annual data protection fee, which is typically £52 or £78 for small businesses (£5 less by direct debit).

Worth knowing: Your legal responsibilities extend beyond payroll to include ensuring a safe working environment and protecting employee's personal data.

Common Mistakes When Hiring Your First Employee

One of the most frequent and costly mistakes is misclassifying an individual's employment status. Describing someone as a 'self-employed contractor' in an agreement is meaningless if the reality of the working relationship is one of employment. If HMRC investigates and reclassifies them as an employee, your company could be liable for backdated PAYE tax, employer NICs, interest, and penalties, often stretching back several years. The tests for employment status focus on control, personal service, and mutuality of obligation. If you dictate how, when, and where they work, and they are an integral part of your business, they are likely an employee. Always err on the side of caution with your first core team member.

Forgetting or delaying pension auto-enrolment is another common pitfall. The duties begin on day one, not when you get around to it. The Pensions Regulator is proactive in enforcing compliance, and fines for late enrolment can be substantial. Similarly, failing to secure Employers' Liability insurance before the employee starts, or not conducting a proper right-to-work check, exposes the business and its directors to significant fines and legal risk from the very beginning. Finally, small errors in payroll, such as using the wrong tax code or miscalculating holiday pay, can create distrust with your new employee and lead to administrative headaches with HMRC. Using reputable payroll software and following a clear monthly checklist can prevent most of these issues.

• **Misclassifying employment status:** Calling an employee a 'contractor' to avoid obligations.
• **Forgetting pension duties:** Failing to set up a scheme and auto-enrol the employee on time.
• **Skipping legal checks:** Not having Employers' Liability insurance or checking right to work before day one.
• **No written contract:** Failing to provide a written statement of employment particulars.
• **Payroll errors:** Incorrectly calculating tax, NICs, or statutory pay.
• **Ignoring data protection:** Not registering with the ICO or handling employee data insecurely.

Common questions

Official sources & further reading

This guide draws on the official guidance below. Rules, fees and individual circumstances can change; check the relevant source before acting.

• GOV.UK - Employing staff for the first time
• GOV.UK - Check if you need to register for PAYE
• The Pensions Regulator - Employer duties and automatic enrolment
• Health and Safety Executive (HSE) - For small businesses

General UK information, primarily for private companies limited by shares. This is not personalised legal, tax or financial advice. An accountant or solicitor can help apply the rules to your situation.