If nobody ever properly explained how payroll works to you, you’re not alone. Most business owners learn it the hard way, by running it once, getting something wrong, and figuring out the rest from there. This guide walks through the whole process in order, the way it actually happens each month, without assuming you already know the terminology.

Step one: start with gross pay

Gross pay is what an employee earns before anything is taken out. It’s usually made up of a basic salary plus allowances, housing and transport being the most common in Nigeria. This total matters beyond just being the starting number. Several statutory deductions are calculated against specific parts of it, not just the basic salary alone, which is one of the more common places payroll goes wrong.

Step two: pension comes off first

Understanding how payroll works starts with getting the order right, and pension is typically calculated early in the sequence. Under the Pension Reform Act, the employee contributes a minimum of 8% and the employer contributes a minimum of 10%, based on basic salary plus housing plus transport, not basic salary on its own. Both portions go into the employee’s Retirement Savings Account, held with a Pension Fund Administrator the employee has chosen.

This has to reach the Pension Fund Custodian within seven working days of salary payment. That window is short, and it’s one of the deadlines regulators have gotten notably stricter about enforcing.

Step three: NHF, if it applies

The National Housing Fund contribution is 2.5%, and since February 2023 it’s been voluntary for private-sector employees, though it remains mandatory for public-sector workers earning the minimum wage or above. If an employee has opted in, this deduction comes next, remitted to the Federal Mortgage Bank of Nigeria within one month.

Step four: work out what’s eligible for relief

This is where how payroll works gets more specific to each employee, rather than being a flat calculation applied the same way to everyone. Under the current rules, Rent Relief allows a deduction of 20% of annual rent paid, capped at ₦500,000, but only if the employee has formally claimed it in writing. Other eligible deductions can include pension contributions already accounted for, NHF where applicable, and a few other specific categories like qualifying life insurance premiums.

None of this is automatic. An employee who doesn’t submit a written rent claim doesn’t get the relief applied, even if they’re clearly paying rent.

Step five: apply the tax bands

With gross pay adjusted for pension, NHF (if applicable), and any claimed reliefs, what’s left is taxable income. As of 1 January 2026, the bands work like this:

• The first ₦800,000 is taxed at 0%
• The next ₦2.2 million (up to ₦3 million total) at 15%
• The next ₦9 million (up to ₦12 million total) at 18%
• The next ₦13 million (up to ₦25 million total) at 21%
• The next ₦25 million (up to ₦50 million total) at 23%
• Everything above ₦50 million at 25%

This is a meaningfully different structure from what existed before 2026, when the old Consolidated Relief Allowance and a different set of bands applied. If you’re still using a formula from before this year, it’s worth double-checking against the current rates.

Step six: net pay, and where the paperwork goes

What’s left after all deductions is net pay, the amount that actually lands in the employee’s account. But the process doesn’t end there. PAYE is due to the State Internal Revenue Service of the employee’s state of residence, by the 10th of the following month. Pension, as covered earlier, has its own seven-day window. And once a year, by 31 January, employers must file an annual PAYE return covering every employee’s pay and tax for the year, a step that’s easy to overlook even when the monthly payments have all gone out on time.

Why this trips people up

Understanding how payroll works in theory is one thing. Running it correctly every month, for every employee, on every deadline, is where it gets harder. The order of deductions matters. The base each percentage applies to matters. And the fact that some of Nigeria’s payroll rules changed significantly at the start of 2026 means a process that worked perfectly well last year might now be producing the wrong numbers with complete confidence.

None of this is a reason to feel behind if you’re only now learning the details. It’s a reason to build the process once, correctly, rather than patching a spreadsheet every time something in the rules shifts under you.

Once the basics make sense, the next question most owners ask is what they’re actually required to deduct for PAYE specifically. That’s covered in our PAYE in Nigeria guide.