National insurance contributions are payable by employers, employees and self-employed people. The contributions build up an entitlement to certain benefits, one of the most important being the UK state retirement pension. People born in the UK are allocated a national insurance number at the age of 16, while people coming to the UK later in life must apply for a number from the Department of Work and Pensions and attend an interview to obtain a number. Those aged below 16 are not required to pay national insurance contributions.
National insurance contributions are divided into certain categories which are referred to as classes, relating to contributions payable in certain circumstances. Many people are liable to pay more than one category of national insurance contributions, either by paying the contributions directly or through an employer.
Primary Class 1 national insurance contributions are payable by employees and are generally deducted from their salary together with income tax. Employers also have to pay national insurance contributions in respect of the employees, and these are referred to as secondary Class 1 national insurance contributions.
Class 1 national insurance contributions are payable at 11% on earnings between the primary threshold and the upper earnings limit. The primary threshold for 2010/11 is £110 per week or £476 per month. The upper earnings limit is £844 per week or £3,656 per month. A 1% rate applies to earnings above the upper earnings limit.
Lower contribution rates apply to employees who are contracted out of the state second pension (S2P) which is an earnings-related supplementary pension. Employees are normally contracted out because they are members of an occupational pension scheme.
Where the employer provides certain benefits to an employee and these are not readily convertible into cash the employer must pay Class 1A national insurance contributions. For example, an employer providing a company car for the exclusive use of an employee, and paying a medical insurance premium for the employee, must pay Class 1A national insurance contributions based on the value of the benefits (computed using methods set out in the law).
Class 1 B national insurance contributions are payable by an employer in respect of an arrangement with the tax authorities called a PAYE Settlement Agreement. Under this agreement, the employer will pay an income tax liability relating to minor or irregular benefits in kind provided to the employee. The Class 1 B national insurance contributions are payable by the employer based on the value of these benefits and the income tax paid.
Persons who are self-employed are liable to Class 2 national insurance contributions, which are payable at a flat rate of £2.40 per week. A person whose self-employed income for the year is less than the “small earnings exception” of £5,075 per annum does not need to pay Class 2 national insurance contributions, but may decide to do so as a means of preserving the entitlement to benefits such as a full state retirement pension.
Voluntary Class 3 national insurance contributions are payable at a flat rate of £12.05 per week by individuals who have not paid enough national insurance contributions in a year to maintain their entitlement to a full state pension, or who are living or working abroad and wish to maintain their payment record and entitlement to the state pension and other benefits.
Self employed people may also be required to pay Class 4 national insurance contributions which are calculated as a percentage of their trading income in a year. Class 4 national insurance contributions are payable with the income tax liability and are computed at 8% on profits between £5.715 and £43,875, plus a further 1% on profits above the upper limit.
Maximum national insurance contributions
Some people may have income from both employment and self-employment, and could therefore be liable to pay both Class 1 and Class 2 national insurance contributions. To ensure that the amount of national insurance contributions paid is not unfairly high for this category of taxpayer, the maximum contributions payable in respect of Class 1 (at the main rate) and Class 2 is limited to the amount that would be payable if the employee paid Class 1 contributions on earnings equal to the upper earnings limit for 53 weeks.
Based on this calculation, the maximum contribution for a person paying main rate Class 1 and Class 2 contributions in 2010/11 was £3,180. Contributions exceeding this amount would therefore be refunded to the taxpayer. However as the 1% rate of Class 1 contributions (on earnings above the upper earnings limit) would still be payable the refund would be reduced to take this into account.
Where a person is paying Class 1, Class 2 and Class 4 national insurance contributions on employed and self-employed earnings in a year, the Class 4 contributions can be refunded where the total contributions paid is higher than the sum of 53 weeks of main Class 1 contributions plus the maximum main rate Class 4 contribution for the year. This refund would however take into account the 1% rate of Class 4 national insurance contributions on profits above the upper limit, which remain payable.
Maximum age for national insurance contributions
Employees stop paying national insurance contributions when they reach the state pension age. The self employed stop paying Class 2 contributions from the state pension age and they stop paying Class 4 contributions from the beginning of the tax year following the tax year in which they reach the state pension age. The state pension age is 65 for men and 60 for women, but the pensionable age for women is to gradually rise to 65 by the year 2020.
Sources:
HM Revenue and Customs www.hmrc.gov.uk
“Taxation” by Alan Melville, fifteenth edition, FT Prentice Hall
Directgov website www.direct.gov.uk