What is National Insurance?
National Insurance (NI) is a fundamental component of the welfare state in the United Kingdom. It acts as a form of social security, since payment of NI contributions establishes entitlement to certain state benefits for workers and their families.
Introduced by the National Insurance Act 1911 and expanded by the Labour government in 1948, the system has been subjected to numerous amendments in succeeding years. Initially, it was a contributory form of insurance against illness and unemployment, and eventually provided retirement pensions and other benefits.
Currently, workers pay contributions from the age of 16 years, until the age they become eligible for the State pension. Contributions are due from employed persons earning at or above a threshold called the Lower Earnings Limit, the value of which is reviewed each year. Self-employed persons contribute partly through a fixed weekly or monthly payment, and partly on a percentage of net profits above a threshold which is reviewed periodically. Individuals may also make voluntary contributions to fill a gap in their contributions record and thus protect their entitlement to benefits.
Contributions are collected by HM Revenue and Customs (HMRC). In respect of employees, this is done through the PAYE system along with Income Tax, repayments of Student Loans and any Apprenticeship Levy which the employer is liable to pay. National Insurance contributions form a significant proportion of the UK Government's revenue.
Class 1 Contributions
For the Employed
The employee contribution is deducted from gross wages by the employer, with no action required by the employee. The employer then adds in their own contribution and remits the total to HMRC along with income tax and other statutory deductions. Contributions for employees are calculated on a periodic basis, usually weekly or monthly depending on how the employee is paid, with no reference to earnings in previous periods. Those for company directors are calculated on an annual basis, to ensure that the correct level of NICs are collected regardless of how often the director chooses to be paid.
Class 2 Contributions
For the Self-Employed
Class 2 contributions are fixed weekly amounts paid by the self-employed.They are due regardless of trading profits or losses, but those with low earnings can apply for exemption from paying and those on high earnings with liability to either Class 1 or 4 can apply for deferment from paying. Class 2 contributions are charged at £3.00 per week and are usually paid by direct debit. While the amount is calculated to a weekly figure, they were typically paid monthly or quarterly until 2015. For future years, class 2 is collected as part of the tax self-assessment process. For the most part, unlike Class 1, they do not form part of a qualifying contribution record for contributions-based Jobseekers Allowance, but do count towards Employment and Support Allowance.
Class 3 Contributions
For those not working
Class 3 contributions are voluntary NICs paid by people wishing to fill a gap in their contributions record which has arisen either by not working or by their earnings being too low.
Class 3 contributions only count towards State Pension and Bereavement Benefit entitlement. The main reason for paying Class 3 NICs is to ensure that a person's contribution record is preserved to provide entitlement to these benefits, though care needs to be taken not to pay unnecessarily as it is not necessary to have contributions in every year of a working life in order to qualify.
Class 4 Contributions
To make additional contributions
Class 4 contributions are paid by self-employed people as a portion of their profits. The amount due is calculated with income tax at the end of the year, based on figures supplied on the SA100 tax return.
Contributions are based around two thresholds, the Lower Profits Limit (LPL) and the Upper Profits Limit (UPL). These have the same cash values as the Primary Threshold and Upper Earnings Limit used in Class 1 calculations.
No class 4 NICs are due on profits up to and including the LPL.
Above the LPL, up to and including the UPL, class 4 NICs are paid at a rate which can vary but has been 9% for several years.
Above the UPL, class 4 NICs are paid at a second rate, which has been 2% for several years.
Class 4 contributions do not form part of a qualifying contribution record for any benefits, including the State Pension, as self-employed people qualify for these benefits by paying Class 2 contributions.