National Insurance – A Class Act
National Insurance was introduced in the UK as long ago as 1911, initially as a contributory fund to provide benefits in the event of incapacity due to sickness or unemployment. Over the years, the scheme has been broadened to include provision of a wide range of social security benefits, and, in particular, as a way of securing a state pension on retirement.
The working population pays contributions according to their employment status, as follows:
CLASS 1 NIC – IN EMPLOYMENT
Employees pay Class 1 NIC, based on a given percentage (currently 12%) of their wage or salary over the Primary Earnings Threshold (currently £149 per week). Contributions are deducted automatically from pay, alongside PAYE income tax, although they are not calculated on a cumulative basis as income tax is. Contributions are also paid on benefits in kind where appropriate.
Employers must also pay a secondary contribution for each employee on earnings over the Primary Threshold (currently 13.8%), and the whole amount is remitted to HMRC through the Employer’s PAYE scheme. Late payments to HMRC are subject to interest and penalties, payable by the Employer, but do not affect the employee’s payment record.
Class 1 contributions are not payable by the employee if:
- The employee is under 16 years of age.
- The employee has reached the state pension age.
Contributions count towards eligibility and amounts awarded to each individual employee in respect of State Pension, Jobseeker’s Allowance, Incapacity, Maternity and Bereavement Benefits.
CLASS 2 NIC – SELF-EMPLOYED
Class 2 NIC is a flat rate contribution (currently £2.70 per week) payable by all self-employed individuals, whether trading alone or in a partnership, regardless of size of turnover or level of profits -although it is possible to apply for a Small Earning Exception if profits are below a certain level (currently £5,725). Registration is automatic when informing HMRC of self-employment which is compulsory within 3 months of commencement of trade.
Payment is made usually by monthly direct debit, although it can be made 6 monthly on or before 31 January and 31 July of each year. There is currently no penalty system in force for late payment, but from April 2014 HMRC can opt to collect arrears through an individual’s tax code.
Class 2 NIC is not payable if:
- The individual is under 16 years of age.
- The individual has reached the state pension age.
- The individual is a married woman or widow who is entitled to reduced rate contributions.
- The individual holds a Certificate of Small Earning Exception.
Contributions count towards Basic State Pension and Maternity Allowance, and eligibility may be affected by late payment, or indeed no payments, because a Certificate of Small Earnings Exception is in force. Contributions do not grant eligibility to Additional State Pension, Incapacity Benefit or Jobseekers Allowance, so it is wise for individuals to consider making their own provision/insurance to cover circumstances in which they would normally wish to claim those benefits.
If self-employment is ceased, HMRC should be advised as soon as possible to avoid receiving demands for unpaid contributions.
CLASS 3 NIC – VOLUNTARY
If an individual has a gap in their contributions, for whatever reason, which might affect their eligibility to State Pension and Bereavement benefits, they can opt to pay voluntary Class 3 NIC (currently £13.55 per week) to maintain their contribution record.
Class 3 contributions cannot be paid by:
- Married women or widows who have already chosen to pay reduced NIC during the same tax year.
- Individuals who have reached State Pension Age during the same year.
- Individuals who are entitled to NIC Credits (although there are exceptions to this).
Payment can be made by direct debit monthly or quarterly, but must normally be paid within 6 years of the end of the year in which there is a shortfall in contributions.
Before undertaking to make voluntary contributions, it is important to establish how much actually needs to be paid voluntarily for any given year, and the advantages of doing so. HMRC grants NIC credits to individuals who are unable to work due to illness or caring for someone, so regular contributions do not always have to be made in the normal way to maintain a complete contribution record.
Self-employed individuals are usually better off paying voluntary Class 2 NIC.
More information can be found here: http://www.hmrc.gov.uk/nic/ca5603.pdf
CLASS 4 NIC – SELF-EMPLOYED
These contributions are made by self-employed individuals as a percentage of profits (currently 9%) between the lower and upper thresholds (currently £7,755 to £41,450). A further 2% is payable on profits above the upper threshold.
The liability is calculated alongside Schedule D income tax with which it is included for collection purposes – and is thereby subject to the same deadlines for payment. Likewise, late payments can attract interest and penalty charges.
Class 4 contributions do not count towards any benefits for the individual, the proceeds being included in the Treasury “pot” to help fund the social security system. In essence, this is another form of income tax.
Class 4 NIC is not payable on profits if:
- The individual is under 16 years of age.
- The individual reached the state pension age in the previous tax year.
- The individual is not normally resident in UK for tax purposes.
Many people will fall under more than one category and so may be paying more than one class of National Insurance in the same tax year.
There are special rules and exceptions for Mariners, EEA Nationals working on UK-flagged vessels and UK nationals working abroad, details of which can be found on HMRC website: http://www.hmrc.gov.uk/ni/index.htm.
Please note: This article is a commentary on general principles and should not be interpreted as advice for your specific situation.