Sarah Bradford outlines National Insurance contributions changes affecting the self-employed from April 2024.
There is no ‘one size fits all’ as far as National Insurance contributions (NICs) are concerned. Different types of contributors pay different classes of NICs. Some classes secure entitlement to the state pension and contributory benefits; others are more akin to a tax. Some classes are earnings-related, whereas other classes of contribution are payable at a flat rate.
As far as the self-employed are concerned, once their profits reach a certain level, they currently pay two classes of contribution – Class 2 and Class 4. However, this is to change with effect from 6 April 2024, as Class 2 NICs are to be abolished from that date.
Nature of Class 2 NICs
Class 2 NICs are flat-rate contributions currently payable by self-employed earners whose profits exceed the ‘lower profits threshold’, set at £12,570 for 2023/24 and aligned with the personal allowance, the primary threshold for Class 1 NICs and the lower profits limit for Class 4 NICs. Thus, the starting point for paying income tax and Class 1, 2 and 4 NICs is the same. For 2023/24, the rate of Class 2 NICs is £3.45 per week.
It is the payment of Class 2 NICs that currently provides self-employed earners with the mechanism to build up entitlement to the state pension and certain contributory benefits. For the year to be a qualifying year, the self-employed earner must pay, or be treated as having paid, 52 weeks’ worth of Class 2 NICs.
From 2022/23, self-employed earners with profits between the ‘small profits threshold’ (£6,725 for 2023/24) and the lower profits threshold are treated as having paid Class 2 NICs at a zero rate. This provides the self-employed earner with a qualifying year for zero contribution cost. Self-employed earners whose profits are below the small profits limit are not liable to pay Class 2 NICs, but can do so voluntarily if they wish to build up their state pension entitlement. At £3.45 per week, this is a much cheaper option than paying Class 3 voluntary contributions at £17.45 per week. A person needs 35 qualifying years for a full single-tier state pension, and a minimum of ten qualifying years for a reduced state pension.
Class 2 NICs are payable via self-assessment with tax and Class 4 NICs; however, they are not taken into account in calculating payments on account. Class 2 NICs for 2023/24 must be paid by 31 January 2025.
Class 4 NICs
The second class of NICs payable by the self-employed is Class 4. Currently, this provides no state pension or benefit entitlement; rather, it operates as a tax on profits. The structure of Class 4 NICs resembles that of primary Class 1, albeit with contributions payable at a lower rate. Class 4 NICs are payable at the main rate on profits between the lower profit limit and the upper profit limit, and at the additional Class 4 rate on profits in excess of the upper profit limit.
The lower profit limit is aligned with the primary threshold for Class 1 NICs and is set at £12,570 for 2023/24, remaining at this level for 2024/25. The upper profit limit is aligned with the upper earnings limit for Class 4 NICs, and both are set at £50,270 for 2023/24, remaining at this level for 2024/25. The main rate of Class 4 NICs is 9% for 2023/24 and 8% for 2024/25. The additional Class 4 rate is set at 2% for both 2023/24 and 2024/25. The reduction in the Class 4 NICs rate from 6 April 2024 will save a self-employed earner up to £377 in Class 4 NICs.
Class 4 NICs are also payable via the self-assessment system, but unlike Class 2 NICs, they are taken into account in working out payments on account.
False start
Class 2 NICs are to be abolished from 6 April 2024. From that date, self-employed earners will only be liable to pay Class 4 NICs; however, the option to pay voluntary Class 2 NICs will be preserved for those with low profits.
The abolition of Class 2 NICs has been a long time coming. Previous attempts have been made to reform the NICs regime for the self-employed. Under proposals that were due to take effect from 6 April 2019 (having already been delayed by one year), Class 2 NICs were to have been abolished, and Class 4 NICs were to have been reformed to provide the mechanism by which the self-employed built up entitlement to the state pension. At that time, self-employed earners paid Class 2 NICs where their profits exceeded the small profits threshold, and then, as now, self-employed earners with profits below the small profits threshold could opt to pay Class 2 NICs voluntarily. The new-look Class 4 made no provision for the payment of voluntary contributions by those with low profits, who would have had to pay Class 3 NICs instead had the reforms gone ahead, significantly increasing the cost of securing a qualifying year.
Due to concerns about the impact of the reforms on self-employed earners with small profits, the proposals were put on hold, with the government committing not to introduce them during the life of the then parliament.
Abolition of Class 2
Since the abandonment of the previous reform proposals, the structure of Class 2 has been changed to bring the treatment of self-employed earners in line with their employed counterparts. A new lower profits threshold was introduced with retrospective effect from 6 April 2022, raising the starting point at which Class 2 NICs become payable, and bringing it into line with the starting point for primary Class 1 and Class 4 contributions. For 2022/23 and 2023/24, self-employed earners with earnings between the small profits threshold and the lower profits threshold are treated as paying Class 2 NICs at a zero rate, giving them a qualifying year without having to pay any Class 2 NICs for it. This mirrors the treatment of employed earners with earnings between the lower earnings limit and primary threshold.
The reforms to the treatment of self-employed earners with low profits have removed the stumbling blocks to the abolition of Class 2 NICs, and the abolition is now to go ahead from 6 April 2024.
For 2024/25 onwards, self-employed earners will pay Class 4 NICs on their profits, where these exceed the lower profits limit of £12,570. This will secure a qualifying year for state pension and contributory benefit purposes. However, self-employed earners with profits between the small profits threshold (which remains at £6,725 for 2024/25) and the lower profits limit will be awarded a National Insurance credit, which will provide them with a qualifying year. Self-employed earners whose profits are below the small profits threshold will be able to make a voluntary Class 2 contribution as now at the current Class 2 rate of £3.45 per week
Example: Impact of the changes
Bob is a self-employed handyman with profits of £20,000 in both 2023/24 and 2024/25.
In 2023/24, he must pay Class 2 NICs of £3.45 per week (£179.40 for the year) and Class 4 NICs of £668.70 (i.e., 9% (£20,000 - £12,570)) – a total of £848.10.
In 2024/25, he will only pay Class 4 NICs of £594.40 (i.e., 8% (£20,000 - £12,570)). He will save £179.40 from the abolition of Class 2 NICs and a further £74.30 from the reduction in the main Class 4 rate from 9% to 8% – a total saving of £253.70.
Bill is also self-employed and has profits of £7,000 in 2023/24 and 2024/25. In 2023/24, he will be treated as paying Class 2 NICs at a zero rate, and in 2024/25, he will receive a National Insurance credit. As his earnings are below the lower profits limit, he will not pay Class 4 NICs in either year. He is unaffected by the changes and continues to secure a qualifying year without actually having to make any NICs.
Betty has earnings from self-employment in 2023/24 and 2024/25 of £5,000. She is not liable to pay contributions in either year, but can make contributions voluntarily at the Class 2 NICs rate. She is also unaffected by the changes.
Practical tip
Check what the changes mean for you, and if your profits are below the small profits threshold assess whether it is worthwhile making Class 2 NICs voluntarily to secure a qualifying year for state pension purposes.
