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National Insurance

National Insurance as a social fund to pay for pensions, unemployment and sickness benefits was first introduced in 1912, but it was only in 1945 that the system was “nationalised” and the modern welfare state as we know it today was born. From the beginning there has always been a link between contributions and benefits but over the years this link has been gradually eroded. Most social security benefits today such as Income Support or Housing Benefit are of the mean-tested type and do not require a contribution record. The introduction of Pension Credits in 2003 eroded the link still further. As a result, many people today think of NI as just another tax.

There are 4 different classes of NI contribution. Employees and their employers pay Class 1 contributions based on a percentage of their earnings under the PAYE system. The self-employed pay fixed weekly Class 2 contributions plus annual Class 4 contributions based on a percentage of profit. Class 3 contributions are paid on a voluntary basis by people wanting to plug gaps in their NI record. Class 1 contributions have gradually increased over the last 30 years and reached historic highs of 12% for employees and 13.8% for employers in 2011.

The NI burden on people earning over £35,000 per annum has also increased since 2008 due to a re-alignment of the upper earnings limit (UEL) to match the combined higher rate tax threshold and personal allowance. In 2007/8 the UEL was £670 per week. It went up to £770 in 2008/9 and £844 in 2009/10. Someone earning £45,000 in each of those 3 years would have seen their annual NI contributions go up by £850. Since 2003 there has also been a 1% upper rate on earnings above the UEL, which was previously an absolute cap, and this went up to 2% in April 2011.

Another recent change was the introduction of an upper accruals point (UAP) in April 2009. This has been fixed at £770 per week since 2009/10 and affects people who are contracted-out of the state second pension. It means that you only benefit from the contracted-out rate of 9.4% up to the UAP and above this you must pay 11% like everyone else up to the UEL. Also, some personal pensions will suffer from a reduced NI rebate. However, earnings above the UAP will not qualify towards state benefits, whether you are contracted out or in the state system. Someone earning £45,000 in 2011/12 and contracted-out would pay extra NI of £61 per annum as a result of this change.

If you work through your own limited company you can reduce or even eliminate your NI liability completely by taking most of the profits as dividend. However, you should pay yourself an amount just above the Lower Earnings Limit (LEL) in order to preserve your NI record. For ordinary employees there is very little you can do to reduce your NI contributions apart from contracting-out of the state second pension and paying the reduced rate. However, if you have more than one job and they are not related, you can benefit from the LEL for each one. Unlike the personal allowance, the LEL applies to each job individually in full. People who are both employed and self-employed should make sure that they do not pay both Class 1 and Class 4 contributions on income exceeding the UEL at the full rate. You can apply for a rebate if you do. Finally, if you run a small business on the side and your turnover is below the LEL, you should not be paying Class 2 contributions. You can apply for a Small Earnings Exception Certificate if that is the case.

If you would like our help with any of the above, please give us a call. The following information sheets will tell you more.

Information Sheets Tax Tips
bulletpoint Employee contributions
bulletpoint Employer contributions
Salary sacrifice schemes
If you take a pay cut in exchange for a tax free benefit such as pension contributions as part of a salary sacrifice scheme, you'll reduce your NI.
Occupational pensions
You can reduce your NI contributions from 11% to 9.4% if your employer has a money purchase pension scheme that is contracted out.
Small earnings
If you have a part-time business and turnover is less than the lower earnings limit, you can apply for a Small Earnings Exception Certificate.
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