Originally, the National Insurance scheme was set up to pay for the then newly established NHS and other state benefits after the second world war as part of the establishment of the welfare state. Workers would pay a percentage of their income so that people who could not work due to age, infirmity or ill health could still have money to live on.
National Insurance – fundamentals
National Insurance Contributions (NICs) are payable to HMRC as a deduction from earnings. Whilst those contributions don’t directly fund things like the benefits system or state pension now, how much you contribute will ultimately determine your level of entitlement to receive certain benefits if ever you were to need them. For example, if you do not pay enough during the course of your working life, you will not be entitled to a full state pension.
Anyone who earns a salary above a certain amount (see below) has to pay NICs, and employers also have to pay NICs for their employees who earn over that amount too.
It is worth noting from the beginning that NICs are only payable on earnings, not on dividends. If you are the director of a company and draw dividends rather than a salary, you will not need to pay NICs on your income from those dividends. Expert advice should be sought as to which would be most tax-advantageous for your particular circumstances: drawing dividends (which attract tax at a rate linked to your income) or a salary. You would still have to pay NICs for any employees who earn over the threshold amount (see below).
There are different classes of NICs that are payable depending on your employment status. The amount you pay is a percentage of your income, and this percentage is set depending on how long you have paid NICs for during your working life, and how much you earn.
Class 1 NICs
These are paid partly by the employee and partly by the employer. If you are both – that is, you run a limited company and take a salary from that company as director – then you will effectively pay twice, once as employer and once as employee.
Employees (including company directors receiving a salary) will pay:
Between 2% and 12% on salaries £162 – £892 per week, depending on their NIC category letter (most employees will be category A and will have 12% deducted).
2% on salaries over £892 per week.
This is taken directly from their gross income by you as employer and paid to HMRC.
Employers (including limited companies) will also pay:
13.8% of each employee’s salary over £162 per week.
Therefore, if you or any of your employees earn a salary of less than £162 a week, neither that employee nor the company will need to pay NICs on that salary. Be wary though of payment of overtime or bonuses as if these boost income above this threshold then NICs will be payable on the affected weeks’ salary.
Your company may also be eligible to claim the Employment Allowance, which will refund up to £3,000 of Class 1 employers’ NICs per year.
However, you can’t claim if you’re the director and the only employee of the company.
Obviously, you can only reclaim employers’ NICs via the scheme if your salaries are above the prevailing NIC thresholds. Many small company directors are remunerated with small salaries which aren’t subject to NICs at all, so the Employment Allowance may not be relevant.
Class 1A or 1B
Under these classes, NICs are also payable by employers in relation to any other benefits paid to your employees, including yourself if you draw a salary (for example, company car, private health care, travel expenses). As an employer, you will pay these NICs directly to HMRC.
To calculate the NICs you need to pay as a company director, you can use the ‘standard annual earnings period’ method or the ‘alternative’ method, depending on how regularly you draw your salary.
Class 2 and 4 NICs
If you are classed as self-employed (perhaps through a partnership), you will need to pay NICs on your income. Class 2 NICs are payable if you earn net profits of over £6,205 per year, and these are currently set at a rate of £2.95 per week. If your net profits exceed £8,424 per year, you will need to pay Class 4 NICs instead – currently, you will need to pay 9% on all profits between £8,424 and £46,350.
Other points to note
If you pay Class 2 or 4 NICs, this can be accounted for through self-assessment. Class 1 NICs must be managed via your payroll system. All NICs are payable each time you run your payroll (for example, every month or week).
The careful use of dividend payments can be used to reduce your company’s liability to NICs as part of a tax-planning package.