National Insurance UK Tax Essentials

UK National Insurance Explained

UK National Insurance explained - The role and organisation of N.I.

A Guide To Direct And Indirect Taxation In The UK – How To Save Money
Chapter Six

Story Highlights:

National Insurance is the topic of this chapter with explanations and facts about:

  • The history of National Insurance – its origins, National Insurance and the Beveridge Report of 1942, changes in N.I. since 1975
  • The role of the National Insurance Fund
  • How National Insurance works nowadays – your N.I. number and N.I. payments
  • National Insurance – who pays and N.I. Classes
  • Proposed changes to National Insurance from 2018
  • The future of National Insurance in the UK
  • Merging income tax and National Insurance – Is it possible?

The history of National Insurance

It’s impossible to understand the role and organisation of National Insurance in the UK nowadays without putting it into its historical context. As a result, this chapter begins with a brief explanation of the origins of National Insurance and its close ties to the beginning of the welfare state. This is followed by a detailed examination of the present-day workings of National Insurance with full explanations about the role of the National Insurance Fund, your N.I. number, who pays and who’s exempt from paying it as well as information about why we pay contributions and how your N.I. payment is calculated.

In the final part of this chapter we look to the future of National Insurance in the UK. Not only do we explain proposed changes from 2018 but we also consider the question – could income tax and National Insurance ever be combined in one tax? If so, what challenges need to be overcome to make this possible?

The origins of National Insurance

Originally National Insurance was a system of weekly payments made by all workers to insure financial aid when they were sick or laid off from work. The Liberal party of Lloyd George introduced the idea of these paid contributions in the National Insurance Act of 1911. All wage-earners between the ages of 16 and 70 had to pay a flat-rate contribution of 4d a week while their employers would pay 3d and the state would add a further 2d.

An old sign of the Post Office in the UK, were National Insurance payments were initially collected by the purchase of special stamps

Initially these payments were collected by the purchase of special stamps from the Post Office, which would be stuck onto cards as proof of the workers’ entitlement. In return, workers would be eligible to a degree of free medical care as well as unemployment benefit of 7 shillings a week for 15 weeks in total a year. At the beginning there were 2 schemes run in tandem: one for health and pensions (administered by approved societies such as Friendly Societies or unions) and a second for unemployment benefits (run by the government). Later Friendly Societies were replaced by the newly-created Ministry of Health (1919) while 1925 saw more welfare provision for widows and orphans.

National Insurance and the Beveridge Report (1942)

As a direct result of the Beveridge Report of 1942, there was expansion and the unification of the welfare state under a scheme of social insurance ‘from the cradle to the grave’. As part of a series of reforms, the National Insurance Act of 1948 created a single stamp, which would cover all benefits and was the responsibility of the new Ministry of National Insurance.

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The underlying principle behind Beveridge’s vision was that you’d only take something out if you’d put something in so that 60% of payments were made only to workers who had contributed to the system. For those who hadn’t contributed, there was a safety net of national assistance which was means-tested rather than contribution-based.

Changes in National Insurance since 1975

1975 can be seen as a turning point in the way National Insurance was calculated, collected and administered. In this year, N.I. contributions were no longer flat-rate but were earnings-related and were collected alongside income tax under the PAYE scheme. Also, the Social Security Act of 1975 established the National Insurance Fund from the merger of the National Insurance & Industrial Injuries Funds (later joined by the Redundancy Fund in 1989). Ten years later, this Fund was transferred from the jurisdiction of the Department of Social Security to the Inland Revenue.

National Insurance contributions were almost doubled in 1990

The biggest increase in N.I. was in 1990 when employees’ contributions were almost doubled (from 6.5% of earnings to 12%). In July 2009, the NPS computer system strengthened the links between N.I. and income tax since they could be recorded on – and accessed from – a single computer system.

Summary:

Weekly National Insurance was introduced in 1912 and was made up of contributions from workers, their employers and the state.

Originally, health/pensions and unemployment benefits were run separately.

The Beveridge Report of 1942 laid the foundations of the post-war welfare state financed by a single N.I. stamp with flat-rate contributions.

1975 saw major changes in the way National Insurance was calculated, collected and administered.

The role of the National Insurance Fund

The National Insurance Fund is theoretically used to finance contributory benefits and many people believe it is ‘ring fenced’ i.e. only used to pay for pensions, sickness/disability benefit, etc. However, in times when its balance has been insufficient for welfare expenditure, it’s been topped up with revenue from general taxation. Since the mid-1990s the National Insurance Fund has had a surplus and has been invested in gilts, which effectively means the government has been lending money to itself and these ‘loans’ don’t necessarily have to be spent on welfare.

Since the mid-1990s the National Insurance Fund has had a surplus and has been invested in gilts.

According to the IFS (Institute for Fiscal Studies), in the 2016-17 tax year, 18.7% of the total National Insurance contributions in the UK were given to fund the National Health service and the remainder was left in the Fund.

How does National Insurance work nowadays?

Now that we’ve considered the historical origins of National Insurance, let’s look at how the system works: how much it is, who pays and who is exempt before examining proposed changes and the future of the scheme.

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Your National Insurance number

You should receive your National Insurance number just before your 16th birthday. Records of Child Benefit payments are used to allocate N.I. numbers, which is why parents should register their children even if they opt out of receiving the benefit for tax reasons.

If you haven’t received your N.I. number or you’re a foreigner coming to work in the UK, you can register for a number by phone on: 0345 600 0643.

Your N.I. number, which consists of both numbers and letters, never changes even if your own personal circumstances do (for example, on marriage). As a result, it allows all of your N.I. contributions and payments of income tax to be attributed to you. Your N.I. number is also necessary for certain government departments as well as for certain financial services such as student loans. Knowing your N.I. number is one of the key pieces of personal information that tricksters need to know in order to commit identity fraud so it’s vital that you don’t share it with anyone. Any documentation with this number on (such as payslips) should be disposed of properly, preferably shredded.

National Insurance payments in the UK

National Insurance contributions are deducted automatically from your wage/salary before you receive it. Your employer will add their own contribution and the combined amount is sent to HMRC. The exception is self-employed people, whose contributions are calculated through their Self-Assessment tax return and usually paid twice a year.

A self-employed jeweller who does not pay National Insurance contributions as he makes a small profit

The only people who are exempt from paying National Insurance are people who are over State Pension Age but choose to carry on working and defer their pension and self-employed people who make profits of under £6,025 per year (although they can pay voluntary Class 2 contributions if they choose).

Paying National Insurance is obligatory; to receive some state benefits such as Jobseeker’s Allowance (contribution-based) or Maternity Allowance, your N.I. record is taken into account. Also, to receive a state pension in the UK, you must have paid 35 years of N.I.

Questions:

How much National Insurance is paid every year in the UK?

In terms of government tax revenue, National Insurance contributions are the second largest after income tax. According to the IFS, in the 2016-17 tax year, National Insurance contributions raised £126.5 billion, which is 17.7% of all tax revenue.

Who pays the most National Insurance?

According to the Office for Budget Responsibility, 93.4% of N.I. contributions are collected through the PAYE system (Class 1A/B – both employers and employees); 2.2% are paid by the self-employed through self-assessment and 4.4% are voluntary contributions.

What are National Insurance Credits?

You’re entitled to National Insurance Credits if you’re unable to work for some reason. For example, you’re a carer or raising pre-school children. Being ‘credited’ with N.I. contributions prevents gaps in your N.I. record, which is important when you wish to have a state pension.

How many benefits are means-tested in the UK?

The number of state benefits which are means-tested have nearly tripled since the beginning of the welfare state in 1948.

To receive a state pension in the UK, you must have paid 35 years of N.I.

Summary:

The National Insurance Fund contributes nearly one fifth of its revenue to the National Health Service and the remainder is invested.

Your National Insurance number is unique to you and is issued to British citizens automatically before their 16th birthday.

National Insurance contributions are deducted through the PAYE system and are necessary to claim some state benefits.

Only employees over State Pension Age and self-employed people with low profits are exempt from paying National Insurance.

National Insurance – Who pays and N.I. classes

To pay National Insurance in the UK, you must be between the ages of 16 and the State Pension Age and be earning over £157 per week. If you earn between £113 and £157 a week, your contributions are considered as paid to protect your future pension.

How much you pay depends on your employment status, how much you earn and whether there are any gaps in your employment record. For easier administration, National Insurance contributions are divided into a number of classes, which are as follows:

Class 1 Employees who earn over £157 a week and are under State Pension Age
Class 1A/B Employers’ contributions
Class 2 Self-employed – including voluntary contributions for those earning under £6,025
Class 3 Voluntary contributions – to avoid/fill gaps in N.I. record
Class 3A Voluntary contributions to top up a state pension
Class 4 Self-employed – with profits over £8,164

Contributions are closely linked to earnings rather than a flat rate as they used to be. Therefore, employees who earn £157-£866 a week, pay 12% of their earnings whilst any weekly income over £866 is calculated at 2%.

Self-employed people with profits up to £8,164 a year pay £2.85 a week for their Class 2 contributions. Class 4 payments are calculated at 9% on profits of £8,164-£45,000 while the rate for profits over £45,000 is 2%. Employers’ contributions in Class 1A/B are calculated at 13.8% although in some circumstances they might be entitled to a rebate.

Proposed changes to National Insurance from 2018

When considering the relative amounts of National Insurance paid by different types of workers, it’s immediately obvious that the percentage paid by the self-employed is considerably less than the Class 1 contributions – both primary and secondary – paid by employers and their employees.

This is partly in recognition of the challenges faced by the self-employed in terms of cash flow and the administrative challenges of having the contributions paid in a lump sum twice a year rather than through the PAYE system and spread over the year.

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However, there are plans to streamline and change the way that National Insurance contributions are paid by the self-employed. Although plans to increase Class 4 contributions in March 2017 were abandoned, Class 2 contributions are due to be abolished in April 2018. In their place Class 4 contributions will be reformed to include a new threshold called the ‘Small Profits Limit’. The self-employed who earn under this amount will be treated as if they paid their contributions so they will be able to access contributory benefits like a state pension.

Class 2 contributions are due to be abolished in April 2018. In their place Class 4 contributions will be reformed to include a new threshold called the ‘Small Profits Limit’.

The impact report by the government has calculated that the 3.4 million individuals who currently pay Class 2 contributions will make an average annual saving of £134 as well as saving money and time on administering the different National Insurance charges.

In order to fund these changes, Class 4 contributions will increase from 9% to 10% in 2018 and then be set at 11% in 2019.

The future of National Insurance in the UK

Like any system in any country and in any historical period, tax payments and administration never remain static but are constantly in a state of change to reflect the changing realities and demands of society.

It could be argued that the separation between income tax and National Insurance is artificial and is purely an historical accident rather than a fact. So why shouldn’t they be combined into one tax?

Summary:

It’s compulsory to pay National Insurance in the UK if you are aged 16-SPA and earn over £157 a week.

How much National Insurance you pay depends on how much you earn, your employment status (e.g. employee or self-employed) and if there are gaps in your N.I. record.

There are plans to reform the way that the self-employed pay National Insurance.

There have been suggestions that income tax and National Insurance should be combined into one tax.

Merging income tax and N.I. – Is it possible?

This idea of combining income tax and National Insurance into one system has been a topic of discussion and controversy for a number of years and has been seriously considered by the Office of Tax Simplification. However, there are a number of problems to overcome: practical, administrative and psychological.

The first concerns the relative thresholds for the two taxes; National Insurance is paid on much lower earnings than income tax (£157 a week compared to £11,500 a year). Where would the thresholds be placed for this tax – somewhere in the middle? And how would this be calculated? Closely linked to this is the period on which it would be calculated – on weekly or yearly earnings?

Downing street, home to the residence of the Prime Minister in London, UK

Another problem which must be solved before we’ll see this merge occur in the UK is that National Insurance contributions are paid on earnings only whilst income tax takes into account all of a taxpayer’s annual income including interest on savings and so on. Therefore, how could this be administered in a way to take this complexity into account?

Last but not least is the psychological aspect. National Insurance may be for all intents and purposes tax under a different name but in the minds of taxpayers (and let’s be honest, voters), it’s closely linked psychologically to the idea of contribution-based state benefits. Increasing N.I. contributions never has the same political fallout for governments as similar increases in income tax since people who pay it in the UK see its consequences in their everyday life. In other words, they receive a state pension, they use the National Health Service, they receive Child Benefit and so on.

The problems of merging income tax and National Insurance aren’t insurmountable but it may have unexpected consequences – not least political.

Questions:

Which state benefits are contributed-based?

Apart from the state pension, contribution-based state benefits are: (contribution-based) Jobseeker’s Allowance, Incapacity Benefit, (contributory) Employment & Support Allowance, Bereavement benefits and Maternity Allowance.

Who would pay Class 3 voluntary contributions?

Class 3 voluntary National Insurance contributions are usually paid by Britons living – but not working – abroad.

How much are Class 3 voluntary National Insurance contributions?

For the 2017-18 tax year, they are £14.10 per week.

How many people in the UK are self-employed?

According to ONS (April 2017), there are 4.78 million self-employed people in the UK or 15% of all people in work.

What’s the difference in the levels of N.I. paid by salaried employees and the self-employed?

For 2017-18, a salaried employee earning £30,000 a year would pay £2,260 in N.I. compared to £2,113 for a self-employed person on the same salary; a difference of over £500 a year.


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About the author

Thomas Henderson

Thomas worked as a consultant in personal finance in the UK for 18 years. He has found a passion in sharing his experience on familymoney.co.uk

Thomas also takes pleasure in woodworking, reading and observing stock market trends.

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About The Author

Thomas Henderson

Thomas worked as a consultant in personal finance in the UK for 18 years. He has found a passion in sharing his experience on familymoney.co.uk

Thomas also takes pleasure in woodworking, reading and observing stock market trends.

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