What is National Insurance and What is it Used For?
National Insurance is one of the payroll deductions and a majority of people do have to face it at some degree. National Insurance is used to fund state benefits such as; state pension, maternity allowance and unemployment allowance. These deductions are indirectly benefiting you or benefiting you for the long-term.
Who Needs to Pay National Insurance?
Employee – For employees, the payroll deduction will be class 1 National Insurance.
Self-Employed – There will be two kinds of National Insurance that you would need to pay when you are making a profit, the first is class 2 and the other is class 4.
Business Owners –As a business owner who has employees working for you need to take care of class 1 as well as the class 1 secondary contribution (i.e. employer’s contribution, which is paid on top of your employees’ gross salary).
Investors – Investment income like stocks and shares, dividend income, when you sell assets or if you rent a home do not trigger any National Insurance. However, if you run a property management business as a sole trader, class 2 and 4 National Insurance may apply to you.
Different Classes of National Insurance and Rates
- Class 1 – As an employee, if you are earning above that then it is 12% till you earn up to £45,000 but after £45,000 it is only 2%. When your earning goes up, the rates go down. When you have multiple jobs, you need to watch out for your overall earning and if it is more than £45,000. If each job is under £45,000 and everything collected is at 12% then you may have overpaid National Insurance so you do need to watch out for that. Currently, if you are earning less than £8,164 you do not have to pay National Insurance.
- Class 2 – This is a flat rate contribution, which means that it is £2.85 on a weekly basis. As a self-employed individual, you do need to declare your income through self-assessment, which is also known as a personal tax return. On your tax return, you will have the tax and the National Insurance, which you will have to pay. If your profit is less than £6,025 then you probably will not have to pay class 2 or class 4.
- Class 3 – This is a voluntary contribution. For instance, if you do not pay National Insurance or if you are an investor and you want to contribute for your state pension then you can voluntarily choose to pay as class 3.
- Class 4 – This has the same threshold as class 1. Between £8,164 and £45,000 it is 9% and above £45,000 it is 2%. It is collected based on the profit you make. It is important to note that in the future the government may abolish class 2 but if that is the case they may increase the class 4 rate.
Special Attention for Small Business Owners
If you decide to incorporate and are a one-man band company, then decide to take salary from the company, if you are taking more than £8,164 a year then you have to have the main class 1 contribution as well as secondary contribution. Secondary contribution is 13.8% which is paid on top of your gross pay.
- Director’s National Insurance – The way director’s pay National Insurance is different to their employees. If you are a normal employee your National Insurance is calculated on a monthly basis but as a director it is calculated on a cumulative basis. For example, if you take £1,000 in month 1, as it is under £8,164 there are no deductions but towards the end of the tax year your accumulative salary is above £8,164 so you start to have more deductions.
- Employers Allowance – Most small businesses qualify for approximately £3,000 per year for employer’s allowance. This amount can be deducted from the secondary national insurance. If the government is giving you a £3,000 exemption, you are able to save up to £3,000 a year. If you are a director-only company, unfortunately this does not apply to you, but if you are a small business then it is very likely you will qualify for it. You can double-check with your payroll bureau or accountant.