National insurance explainer (Budget October 2024 update)

This is part of a series of explainers on topical tax issues produced by the Chartered Institute of Taxation

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 government doing?

The government are making four changes to employer National Insurance contributions (NICs), all of which take effect at the start of the next tax year (6 April 2025).

Two of the changes are big tax increases - reducing the secondary Class 1 National Insurance (employer) threshold from £9,100 to £5,000 per annum, and increasing the main rate of secondary Class 1 National Insurance (employer) contributions from 13.8% to 15%. The Class 1A and Class 1B employer rates, which apply to taxable benefits-in-kind, will also increase in line with this.

In partial compensation the government are increasing the generosity of the Employment Allowance in two ways. All employers will be able to claim it (rather than just employers who have incurred an employer NICs liability of less than £100,000 in the tax year prior) and the amount each employer can save will rise from £5,000 to £10,500.

The net revenue raised by these four changes is predicted (see p38 of this document) to be just under £24 billion in 2025-26 rising to just under £26 billion in 2029-30.

The government will also uprate (increase) the Class 1 Lower Earnings Limit for 2024-25. This is the starting point at which employees begin to pay National Insurance.

This follows cuts to national insurance for employees introduced by the previous Conservative government, which reduced the main rate from 12% to 10% in January 2024 and then to 8% in April 2024.

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 is only levied on earnings
• National Insurance has different rates for the employed and self-employed, income tax has a single set of rates for everyone in employment
• Income tax is aggregated across all employments and other sources of income whereas for National Insurance each separate employment is treated in isolation
• Pensioners are 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 £311 billion from income tax. Until this year it was the second biggest revenue raiser but following the employee rate cuts it is expected to be overtaken by VAT (£176 billion). Next year (2025-26) NICs is expected to raise £199 billion taking it back above VAT.

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 'pay as you go' 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).

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 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. If the fund builds up a good surplus then it lends money to other parts of government, effectively reducing the national debt.

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

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

Yes. Payment of NICs builds 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.

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 April 2024 Class 2 NICs is no longer compulsory) and Class 3 is for voluntary contributions.

How much NI does an employee currently 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, an employee is treated as if they have made a contributory payment, which maintains their entitlement to contributory benefits. 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 will employees pay from 6 April 2025?

The LEL for 2025-26 will be increased from £123 per week to £125 per week. However, the PT, the threshold at which employee Class 1 NICs start to be paid, will remain the same at £242 per week. The UEL is also being kept at its current threshold of £967 per week for 2025/26. This means that there will be no change to the amounts of NI an employee pays in 2025/26, when compared to the current tax year.

How much NI do employers currently 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 will employers pay from 6 April 2025?

The employers ST is being reduced from £175 per week to £96 per week for 2025-26. This means that employers will have to begin paying employer Class 1 NI on lower earnings.

For someone earning £20,000 in 2025-26 their employer will pay. £2,250 in secondary Class 1 NICs. That is an increase of £746 (or nearly 50%). For an employee earning £40,000 in 2025-26 the employer will pay £5,250. This is an increase of £986 (or about 23%). For an employee earning £60,000 in 2025-26 the employer will pay £8,250. This is an increase of £1,226 (or about 17.5%).

Has the total amount of National Insurance on earnings really changed that much?

While the effective total Class 1 NICs (employer plus employee) rates are not significantly different now than they were in 2010-11, the threshold at which employers’ NI starts to be paid will be significantly lower in 2025-26 than it was in 2010-11. In 2010-11 the main employee Class 1 NIC rate was 11% and the employer rate was 12.8%. In both cases Class 1 NICs began to be paid on weekly earnings over £110. The effective total rate was therefore 23.8%. Compared to that the rates proposed for 2025-26 are 8% (employees) and 15% (employers) with Class 1 NICs kicking in on earnings over £242 for employees and £96 for employers. The effective total rate will therefore be 23%.

These figures do ignore the effect of the Employment Allowance, which allows eligible employers to reduce their total secondary Class 1 NICs bill for the year by £10,500 (for 2025-26) (£5,000 for 2024-25). It also ignores the effect of the Apprenticeship Levy, which requires employers with a total pay bill of over £3 million to pay a levy of 0.5% on the excess.

How much NI do the self-employed pay?

The self-employed (including self-employed partners of partnerships) pay Class 4 NICs 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 NICs. A self-employed person making a profit of £40,000 this year will pay £1,645 in NICs. A self-employed person making a profit of £60,000 this year will pay £2,456 in NICs.

The lower annual profits threshold will remain frozen at £12,570 for 2025-26. As will the upper annual profits level at £50,270. And the Class 4 NIC rates remain unchanged at 6% (for profits between the lower and upper annual profits levels) and 2% (for profits over the upper annual profits level).

What if I’m not working but want to maintain my contributions record to qualify for the state pension?

Voluntary Class 3 contributions may be paid by individuals not liable to or credited with NICs on earnings from employment or self-employment to ensure that they qualify for the state pension and bereavement benefits. Class 3 NICs are charged at a weekly flat rate, set at £17.45 for 2024/25. This will increase to £17.75 for 2025-26. Alternatively, the self-employed with profits under the lower annual profits limit may pay voluntary Class 2 NICs at a rate equivalent to £3.45 per week (to increase to £3.50 for 2025-26).

We told you it was complicated!

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

Correct. NICs are only paid by individuals below pensionable age (though employers of individuals over pensionable age are still liable for employer’s secondary Class 1 contributions). The earnings (from employment or self-employment) of individuals over state pension age are exempt from paying NICs but remain liable to income tax.

Additionally, pensions (including the state pension) are 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 are NICs 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. IFS look at the arguments on pages 38-39 of this note. They conclude that “the difference in entitlements is far too small to justify the current tax advantages.”

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 (which will become 15% from 6 April 2025), 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