National Insurance - an explainer

This explainer is part of a series produced by CIOT for the 2024 general election.

You can also watch our video explainer.

What is National Insurance? 

National Insurance is a tax on earnings that is paid by both employees (from their wages) and by employers (on top of the wages they pay out), as well as by the self-employed (from their trading profits). 

Technically National Insurance is a social security contribution rather than a tax, but really, it’s a compulsory payment taken from you by the Government, so, to all intents and purposes, it’s a tax. 

What are the Conservatives proposing?  

The Conservative manifesto states that the party “will cut employee National Insurance to 6% by April 2027 – meaning that we will have halved it from 12% at the beginning of this year”. It adds that their “long-term ambition, when it is affordable to do so, is to keep cutting National Insurance until it’s gone” – but there is no specific timeframe attached to this. 

Additionally the manifesto states that the party will abolish the main rate of National Insurance for the self-employed (Class 4 NICs) by the end of the next Parliament. The manifesto continues: “This will not affect their entitlement to the State Pension. This... means that 93% of self-employed people – four million of them – will no longer pay self-employed National Insurance.” 

Keeping employee NICs at 6% while scrapping self-employed NICs would significantly increase the differential between tax treatment of employment and self-employment, something Rishi Sunak himself said in 2020 was ‘hard to justify’ when the differential was just 3% (see below for full quote). 

There is no proposal to cut employers’ National Insurance. 

So National Insurance is a tax on income, but it’s different from income tax? 

Yes. In a review in 2016 the Office for Tax Simplification identified 84 ways in which income tax and National Insurance contributions (NICs) are different. Some of the bigger ones are - 

• Income tax is levied on your annual income, whereas NICs (for employees) are levied for each earnings period (so typically monthly or weekly) without reference to any previous pay or NICs deductions 
• Income tax is levied on all income (including earnings and also pension, investment, property and dividend income) whereas NICs are only levied on earnings from employment or profits from self-employment 
• National Insurance has different rates for the employed and self-employed, income tax has a single set of rates for everyone in work (whether employed or self-employed) 
• Income tax is calculated based on the total income from any employments, self-employments or other sources of income that a person has in a particular tax year, whereas for National Insurance, each separate employment is usually treated in isolation, with a separate NIC threshold for each employment (unless the employers are connected), although self-employed profits are aggregated into a single ‘trading income’ figure when calculating self-employed NICs 
• Those who have reached state pension age are generally exempt from NICs  
• NICs are paid by employers as well as workers 

How much does National Insurance raise? 

NICs are forecast to raise £168 billion this year (2024/25). This compares with forecast receipts of £303 billion from income tax. Until this year it was the second biggest revenue raiser but following the rate cuts it is expected to be overtaken by VAT (£176 billion). 

Most NICs (about four-fifths for 2022/23) are paid into a separate ‘National Insurance Fund’, which is kept separate from all other revenue raised by taxation. The remaining NICs revenue goes to the NHS. 

A National Insurance Fund? What does it fund? 

It funds contributory benefits such as the state pension, contributions-based jobseeker’s allowance, contributory employment and support allowance, maternity allowance, and bereavement benefits. 

The fund operates on a ’current need’ basis; i.e. this year’s contributions pay (broadly speaking) for this year’s benefits (of which state pensions amount to about 90% of the benefits paid out). If you pay NIC, you are effectively paying for the benefits and state pension received by today’s claimants, your contributions are not set aside by the government to be paid out when you reach the state pension age or need to claim other benefits in the future. 

However while the fund is limited by law (the Social Security Administration Act 1992) in terms of what it can be used for it would be wrong to think of it as a totally ring-fenced pot of money. If the fund builds up a good surplus then it lends money to other parts of government, effectively reducing the national debt. 

On the other hand, if the fund runs low and there is a risk of there not being enough money in it to pay the benefits in question the Treasury tops it up from general government funds.  

There is no automatic relationship between the total amount raised from NICs and the generosity or otherwise of contributory benefits. 

If employee /self-employed National Insurance was scrapped what would happen to the National Insurance Fund? 

If NICs were significantly reduced or scrapped then the National Insurance Fund would quickly run out of funds without another source of funding - current practice is to aim to maintain the level of the Fund at a working balance of at least 1/6th (16.7%) of projected annual benefit expenditure, which would suggest that the fund would be exhausted in a couple of months if no new NIC receipts were to be added to it. 

This said, there is no suggestion that employer NICs are to be scrapped and, at present, they account for approximately 60% of NICs receipts. However, at current levels, receipts from this source alone will be insufficient so one might reasonably expect that a government would either have to introduce a new source of funding or, more likely, ‘top-up’ the National Insurance Fund regularly out of general taxation revenues received by the Exchequer. This would be the case even if it was decided to remove the provision that allocates a proportion of NICs to the NHS – and this too would mean a need to provide greater funding out of general taxation. 

Does the amount of National Insurance I pay affect the benefits I might get personally? 

Broadly, yes. Payment of NICs, or being treated as having paid them, at a certain level can build up your entitlement to the state pension and to other contributory benefits, such as the ones mentioned above. 

How does the amount of National Insurance I pay affect my state pension entitlement? 

A single-component flat-rate state pension replaced the two-component system for individuals who reach state pension age on or after 6 April 2016. The latest rules provide, broadly, that in order to get a full state pension an individual must have paid or have been credited with Class 1, 2 or 3 NICs on an amount equal to 52 times the Lower Earnings Limit (see below) in each of 35 ‘qualifying years’ of working life. 

What would happen to my pension or benefit entitlement if employee / self-employed National Insurance was scrapped? 

At present, we have a system whereby individuals can be credited with ‘notional’ NIC payments. For example, an employed individual earning above the ‘lower earnings limit’ (£123 per week in 2024-25) but below the ‘primary threshold’ (£242pw in 24-25) does not pay NICs but is credited with paying them. A similar rule applies to the self-employed – for 2024-25 onwards self-employed individuals are not required to pay Class 2 contributions but those with annual profits in excess of the small profits threshold (£6,725 for 2024-25) continue to qualify for state benefits. And those with profits below the small profits threshold can choose to pay Class 2 NICs voluntarily to get access to the same benefits. 

Hence, it might be expected that a similar system of notional credits would be introduced if employed / self-employed NICs were scrapped. This could, for example, be based on annual earnings (whether from employment or self-employment). 

Alternatively a government could decide to move away from the concept of contributory benefits altogether, though no party has indicated any wish to do this. 

 

Further Information on how National Insurance works 

Can you explain the different rates and classes of NICs? 

Yes. It’s a bit complicated, but here goes. 

NICs are paid by employees, employers and the self-employed. The amounts of NICs payable and the rules for collecting them depend upon which ‘class’ of NIC is payable and the contribution rate. Class 1 (primary) is paid by employees, Classes 1 (secondary), 1A and 1B by employers, Classes 2 and 4 by the self-employed (albeit from this April Class 2 NICs are usually only ‘treated as paid’ (effectively at a zero rate) or are otherwise  payable voluntarily – more on this when we explain NI for the self-employed in more detail below) and Class 3 can be paid by anyone else, including those not working (another form of voluntary NIC). 

There are also certain NIC credits available to some people. NIC credits are different to NIC payments made or ‘treated as paid’ when you are working (or contributions made voluntarily). They are basically ‘free’ credits which help maintain your National Insurance record in certain situations where you do not work or might have a limited ability to work (for instance when caring for children). You can read more about NIC credits on the LITRG website.  

How much NI does an employee pay? 

Employees are liable to primary Class 1 NICs on their earnings if they exceed the Lower Earnings Limit (LEL). The LEL is set at £123 per week for 2024/25. A zero rate of NICs is, however, charged on earnings between the LEL and the primary threshold (PT), which is set at £242 per week. In effect, while no NIC is paid on earnings between these two thresholds, the NIC is ‘treated as paid’, which maintains their entitlement to contributory benefits for that payment period. Earnings above the PT are charged NICs at a rate of 8%, subject to a cap at the upper earnings limit (UEL), which is set at £967 per week. Earnings above the UEL are charged NICs at a rate of 2%. Where a worker has more than one concurrent employment these thresholds are applied separately against the earnings from each job (unless the businesses are connected) but liability to NIC is subject to an ‘annual maximum’ where combined earnings exceed the UEL, which broadly limits liability on combined earnings above the UEL to 2%. 

What this means is that an employee earning £20,000 this year (2024-25) will pay £594 in primary Class 1 NICs. An employee earning £40,000 this year will pay £2,194. An employee earning £60,000 this year will pay £3,210. These calculations assume income is evenly spread through the year. (You can use Which’s National Insurance Calculator to work out how much you are due to pay this year.) 

How much NI do employers pay? 

Employers pay secondary Class 1 NICs on employee earnings at a rate of 13.8% on earnings above the secondary threshold (ST). The ST is set at £175 a week for 2024/25. Employers are also liable to pay Class 1A NICs on benefits provided for employees, and Class 1B NICs on PAYE Settlement Agreements (PSAs), both at a rate of 13.8%. There are various exemptions and allowances employers can claim, including exemptions for employees under 21, apprentices under 25, armed forces veterans, and freeport employees (these are subject to upper limits). In addition, small employers can claim the ‘employment allowance’. This provides a flat rate deduction for businesses and charities against their annual employer NICs bill. The Allowance has been set £5,000 since April 2022. From April 2020, the Allowance may only be claimed by employers with an employer NICs liability below £100,000 in their previous tax year. 

What this means is that for someone earning £20,000 this year their employer will pay £1,504 in secondary Class 1 NICs in 2024-25. For an employee earning £40,000 this year the employer will pay £4,264. For an employee earning £60,000 an employer will pay £7,024. These amounts are all on top of the salary paid to the employee and in addition to the employee NICs mentioned above. These calculations assume income is evenly spread through the year and no special factors, exemptions or allowances apply. 

How much NI do the self-employed pay? 

Class 4 NICs are charged on annual profits over the lower annual profits limit (£12,570 in 2024-25). Class 4 NICs are charged at a rate of 6% on profits between the lower annual profits limit and an annual upper profits limit (£50,270). Profits above the upper limit are charged NICs at a rate of 2%. 

What this means is that a self-employed person making a profit of £20,000 this year (2024-25) will pay £445 in Class 4 NICs. A self-employed person making a profit of £40,000 this year will pay £1,645 in Class 4 NICs. A self-employed person making a profit of £60,000 this year will pay £2,456 in Class 4 NICs. 

What if I’m not working (or only earning a very small amount) but want to maintain my contributions record to qualify for the state pension? 

If you have not paid (or have not been ‘treated as having paid’) sufficient NICs on earnings from employment or self-employment, you may choose to pay voluntary contributions to ensure that you have a qualifying year for the purposes of state pension and other benefits. Class 3 NICs are charged at a weekly flat rate, set at £17.45 for 2024/25. Alternatively, self-employed people with profits under the lower annual profits limit are entitled to pay voluntary Class 2 NICs instead at a rate equivalent to £3.45 per week. 

We told you it was complicated! 

And I don’t have to pay National Insurance after reaching State Pension age?  

As a general rule, this is correct. 

NICs are only paid by employees  below state pension age (though employers of individuals who have reached state pension age are still liable for employer’s secondary Class 1 contributions). Employed earnings of individuals over state pension age are exempt from NICs but remain liable to income tax. 

Self-employed people remain liable to Class 4 NIC for the whole tax year in which they reach state pension age.  

Pensions (including the state pension) are not considered ‘earnings’ and are therefore exempt from NICs (even where an individual receives a company or personal pension below state pension age) but they are liable to income tax. However, unlike with income tax, there is no NICs relief on personal contributions to private pensions (ie you pay NICs on the portion of your earnings you contribute into a private pension but don’t pay income tax on it). 

This is one reason why some employers offer salary sacrifice schemes for pension contributions whereby the employee contractually agrees to reduce their salary in return for the employer increasing their pension contributions to (usually) the employer’s pension scheme. Such arrangements retain the income tax relief for pension contributions and, effectively, also result in a reduction in NICs payable by both the employee and employer. Salary sacrifice can, however, lead to adverse effects for some employees, so it’s prudent to seek some advice before entering into such an arrangement. 

How is NIC calculated on wages? 

As mentioned above, for employers and employees (but not directors) the amount of Class 1 NIC payable is based on the ‘earnings period’ rather than the tax year. This means that for monthly paid employees the amount of NIC payable each month is based on that month’s earnings. The result of this is that where an employee’s pay is variable, rather than averaging out the NIC payable over the tax year (as happens with income tax), each month is looked at in isolation. This can mean that if a bonus is received one month that pushes an employee’s pay over the Upper Earnings Limit that month their liability reduces to 2% on the proportion above the limit, even though across the tax year their earnings may not exceed the annual equivalent. Since the self-employed pay NIC based on annual profits this means that self-employed people with ‘lumpy’ earnings could pay more than an employed individual with ‘lumpy’ earnings, though NI rates for the self-employed are lower so you could argue it’s ‘swings and roundabouts’. 

And you pay less if you are self-employed? 

Yes, as indicated above, the annual profits of self-employed workers between £12,570 and £50,270 are liable to 6% NICs, while an employee on an equivalent regular wage is liable to 8% NICs. 

Those who defend a lower rate for the self-employed generally argue that it reflects a lower entitlement to state benefits for the self-employed, however this differential has reduced in recent years. Rishi Sunak himself said to MPs back in March 2020, when he was announcing the Self-Employment Income Support Scheme, that: "It is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future." Interviewed by The Sun during the 2020 party conference Sunak stood by this point, saying “the way that we have treated the self-employed has been comparable to how we've treated those who are employed” and “[t]hat is something that we should all reflect on because there is a difference currently in the [tax] system.” 

It’s worth noting that the 2% difference between NI rates paid by the employed and self-employed is dwarfed by the 13.8% cost of employers’ NICs, levied on wages paid to employees but not on payments made to independent contractors. Avoidance of employer NICs is one of the main drivers of misclassification of individuals as self-employed rather than employed (i.e. false self-employment). Those affected miss out on employment rights such as national minimum wage, holiday pay and sick pay. 

Can you reduce your NI bill by incorporating? 

Yes. The NIC system is sometimes manipulated by incorporating a business and trading through a company instead of being self-employed. Company directors can minimise their tax burden by paying themselves (as the sole ‘employee’) a wage up to the primary threshold at which employee and employer NICs become liable. More on this here. 

Do other countries levy National Insurance equivalents? 

Yes. For example, each EU country has its own social security laws and levy their own form of National Insurance (social security). There are, however, big differences in the way different EU countries have organised who pays (and what they pay) and which benefits, healthcare and other social security services the contributions fund. For example, in Germany social security contributions are primarily financed though employee and employer contributions. These can total up to about 40% of wages (with as roughly 50:50 split between employee and employer contribution) but are subject to a wage cap. These contributions fund health, long-term care, pension, unemployment and occupational accident insurance entitlement. 

Social security contributions are also levied in non-EU countries. For example, in the USA social security is payable (with some exceptions) by employees (and their employers) and the self-employed. Broadly speaking, these contributions fund benefits for retired individuals, disabled persons and dependants. 

It is worth noting that, subject to a few exceptions for working temporarily abroad, the obligations and rights under each country’s laws are the same for all workers in that country, whether those workers are local or from abroad. Also, the UK’s social security rates are relatively low compared with most of Europe. Equally the UK’s maximum pension amount is also relatively low compared to Europe. Child benefits are on the higher side of average in the UK compared to mainland Europe. Similarly with maternity benefits. 

International double social security agreements try to limit the extent to which migrant and expatriate workers are ‘in and out’ of different social security systems and try to avoid them having to make double contributions. 

This explainer was written by: 
Matthew Brown, Technical Officer, Chartered Institute of Taxation 
George Crozier, Head of External Relations, Chartered Institute of Taxation 

Originally published 10 June 2024 with edits 11 June and 26 June