National Insurance Contributions (NICs) are a type of tax paid upon earnings for employees and the self-employed. NICs are the UK’s second largest tax revenue source, after Income Tax. NICs are only paid by those who earn over the tax threshold annually.
What are NICs?
The majority of revenue from NICs is generated by employer contributions. Followed by employee contributions. Class 2 and 4 NICs make up the smallest percentage of NICs revenue, due to lower rates paid by self-employed workers and a smaller self-employed workforce. NICs are not charged on other sources of income such as savings, pensions or property. Payment of NICs for enough qualifying years entitles you to receive certain social security benefits, usually the state pension. So in theory you are paying into a savings account that will pay out benefits to you when needed. Although this is not really how it works in practice, meaning that NICs basically act as a second income tax.
The History of National Insurance
Originally National Insurance was brought in as a system of earners making contributions in exchange for entitlement to specific ‘contributory’ social security benefits. Over time this link between contributions and benefits has chipped, to the point where there is barely any tangible correlation between the amount of NICs paid and the amount of benefits received. This is due to the many reforms to both contributions over the years with little perceived need to maintain a meaningful connection. Nowadays the largest contributory benefit is the state pension. There are restrictions upon who is eligible to receive a state pension and as we have seen, the date of eligibility is now a sliding scale for younger generations becoming the age of eligibility.
What Income is Subject to NICs?
Individuals aged 16 or over are eligible to pay NICs. Individuals over the state pension age are not liable for NICs as an employee or self-employed, but employer NICs will still be due on earnings of this nature. Income from savings and investments, property management including rent charged, private pensions, state pensions and other social security benefits are not subject to NICs. Allowable expenses can be deducted from the taxable income on which NICs are due. Private pension contributions made by an employee or self-employed individual cannot be deducted from earnings for the purpose of calculating NICs. Since NICs are not applied to the future pension income they generate, unlike income tax. Pension contributions made by an employer on behalf of their employees are not included in earnings for the purposes of NICs. This means that remuneration in the form of employer pension contributions is not subject to NICs: there are not any NICs when the money is paid into the pension, and not any NICs when money is received from the pension.
NICs are divided into several classes. Class 1 NICs are applied to income from employment. Employees pay primary Class 1 NICs. Employers pay secondary Class 1 NICs. Employee NICs are taken out of earnings, however employer NICs are paid on top of earnings. Essentially employer NICs have a tax-free threshold per employer as well as a tax-free threshold per employee. The employment allowance reduces each employer’s accumulated NICs liability by up to £4,000 a year, provided that their liability in the previous year was under £100,000, plus that as the company director you are not the sole employee earning above the secondary threshold. This negates small employers from paying employer NICs altogether. However much employer NICs revenue comes from big employers which are not eligible for the employment allowance. Employer NICs are not payable on the earnings, up to the upper earnings limit (UEL), of employees aged under 21 or apprentices aged under 25. Find the current NICs rates for employees and employers here.
NICs Rates for Self-Employed Workers
Self-employed workers pay two classes of NICs. Class 2 NICs and Class 4 NICs. Class 2 NICs are paid at a flat rate and apply to all self-employed workers. It’s important to remember that as a self-employed worker you will owe the relevant amount of Class 2 NICs to HMRC, even if you do not owe income tax, since Class 2 NICs are paid at a flat rate. Class 4 NICs are paid relative to annual profits earned above the current threshold. Find the current self-employed NICS rates here.
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