What is National Insurance and what are the NI classes?

What is National Insurance and what are the NI classes?

What is National Insurance and what are the NI classes?

What is National Insurance and what are the NI classes?

National Insurance (NI) is an additional tax on jobs that is paid by employees, the self-employed and employers. Your National Insurance contribution is separate from income tax, tax on self-employed profits and corporation tax. The payment of a National Insurance contribution (or an equivalent number of National Insurance Credits) over several years will build entitlement to a state pension and/or other benefits.

When was National Insurance Introduced?

National Insurance was established by the National Insurance Act of 1911 and was initially devised as insurance should workers become ill or injured and unable to work. Over the years the remit of National Insurance has expanded to cover state pensions and benefits.

What is National Insurance used for in the United Kingdom?

In 2021-22 the UK Government forecast National Insurance contributions (NICs) to raise in the region of £160 billion, representing over 18% of all taxes raised. This is the equivalent of £5,600 per household and nearly 7% of the total national income.

The actual National Insurance payments made by employees, employers and self-employed under the category of National Insurance build an individual’s entitlement to:

• A new state pension.

• Older format state pensions.

• Job seeker’s allowance.

• Employment and support allowance.

• Maternity allowance.

• Bereavement support allowance.

The money collected by the treasury under National Insurance is pooled in a separate pot from other tax revenues which is known as the National Insurance Fund. However, although it would be nice to consider this fund as ring-fenced and separate from other treasury funds, money actually flows in and out of the fund, depending on whether the fund is in deficit or surplus. Interestingly, the Government actually invests the surplus cash from this fund to reduce the National debt.

In the future though, given an ageing population and the requirement for larger state pension payments, it may be the case that the money raised from National Insurance contributions won’t be sufficient to keep the fund at a level where it can pay all the state pensions each month. As a result, either national Insurance rates will have to increase, placing a higher tax demand on the working population, or general taxes will have to increase so the treasury can make continuous top-ups to the National Insurance fund from general tax receipts. In any case, the total tax burden on those on work will likely increase over time.

What is a National Insurance Number (NI number)?

Every individual in the UK is allocated a National Insurance number (also known as an NI Number) at birth and those that arrive from overseas can apply for a National Insurance number if they wish to qualify for benefits. Be aware though that a National Insurance number is not required to work in the UK, if you can prove you have the right to work in the UK.

The very first National Insurance Number was A1 and employers had to purchase approved stamps to record each payment of National Insurance on official contribution cards. These cards acted as proof of entitlement to several benefits and were handed to an employee once they left work. As time went on, the systems were streamlined into a single stamp and a single card.

As the systems continued to develop, National Insurance rates evolved, different classes were established and the means of making National Insurance contributions were combined with income tax collections under the PAYE system (Pay as You Earn).

How many years of National Insurance payments do I need to make to qualify for a state pension?

In the UK, individuals must typically have NI contributions on their record for a minimum of 10 years to be eligible for any new state pension payments and to qualify for the full state pension, you must have 35 years of NI contributions on your record. This means that if you start work at 16 and get a full contribution or credit on your account for 35 years, you will have entitlement to the full state pension at age 51. Similarly, if you don't start working until 21, you won't have full state pension entitlement until age 56. Although, if you’re in a situation where you have paid your full 35 years before state pension age, you will still have to continue paying if your earnings are above a certain level. NI only stops being payable when your earnings cease, fall below a certain level or you reach state pension age.

Be aware that it is possible to log into your National Insurance account online, review your contributions records and make additional payments (under Class 3) should you have any gaps in your record.

Can I stop paying National Insurance (NI) after 35 years?

No, you cannot stop paying National Insurance after 35 years. Once you have 35 years of National Insurance contributions (or National Insurance credits), you will not build any further entitlement or receive a larger state pension than the maximum available at the time (when you reach state pension age) but a National Insurance contribution still must be paid, alongside income tax. By the same token, earning more money and therefore paying more National Insurance will not accrue any additional entitlements or accumulate the 35-year payment target any quicker.

How much is National Insurance in the UK?

The amount of National Insurance paid varies, depending on how much you work, whether you are an employer and how much your earnings are profits are. For this reason, National Insurance is various classes, each with different thresholds and allowances.

It's important to note that Class 1, 2 and 3 National Insurance contributions get credited to an individual's National Insurance record whereas Class 1A, 1B and 4 do not go towards any future entitlements, but must still be paid if they are due.

The best place to find the latest rates of national Insurance is to use the UK Government’s National Insurance webpage. However, read on to find out about the different classes of National Insurance.

What is Class 1 National Insurance (Class 1 NIC)?

Class 1 National Insurance (Class 1 NIC) is the main class of NI and is paid by both an employer and their employee. The part paid by the employer is known as the primary contribution (employer NICs) and the part paid by the employee is known as the secondary contribution. For most employees, this is all done automatically under PAYE and the employer will send the full payment (primary and secondary contributions) to HMRC (HM Revenue and Customs) directly.

The amount paid under Class 1 National Insurance varies a great deal and is dependent on many factors including pay frequency, whether you are a company director, earnings, age, marital status and, of course, whether you are a mariner or fisherman!

What is Class 2 National Insurance (Class 2 NIC)?

Class 2 National Insurance (Class 2 NIC) is a fixed weekly payment that is made by those that are self-employed, within a set profits band. Above this band, you will make additional Class 4 National Insurance contributions. These payments go towards your National Insurance Record and credit your account for future state pension entitlement.

What is Class 3 National Insurance (Class 3 NIC)?

Class 3 National Insurance (Class 3 NIC) is the category of National Insurance under which individuals can use to make additional payments (a voluntary contribution) to fill in gaps in their National Insurance record and build entitlement to a state pension. The payments are known as voluntary national insurance contributions.

What is Class 4 National Insurance (Class 4 NIC)?

Class 4 National Insurance (Class 4 NIC) is the additional National Insurance contributions made by the self-employed with annual profits over a certain threshold. They are typically calculated at the end of a tax year as part of the self-assessment process and don't build any additional state pension entitlement as the self-employed have typically covered this with their Class 2 contributions.

Conclusion.

National Insurance can be quite complicated but is an important source of revenue that is used by the Government to pay for state pensions and certain benefits. Understanding your own personal national insurance payment record is crucial to making sure that you build the right amount of qualifying years and therefore achieve the highest possible state pension in retirement. The best place to start with understanding the different National Insurance rates, liabilities and to review your own record is on the UK Government’s National Insurance webpage.

What’s next?

If you need help or advice on your personal or business finances or if you want to consider investing to make your money work harder, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation and although we are based in Tunbridge Wells, we advise clients across the UK.

This article offers information about financial planning and should not be taken as personal advice. Tax rules can change, and the benefits depend on individual circumstances.