Sarah Bradford explains the National Insurance contributions landscape for 2020/21.
National Insurance contributions (NICs) are payable by employees, employers and by the self-employed. However, not all classes of NICs are equal. Some classes provide the means to earn entitlement to the state pension and contributory benefits, whereas others are more akin to a tax.
The rates and thresholds also vary across the classes.
Employees and employers
Class 1 NICs are payable by employees (primary contributions) and employers (secondary contributions) on earnings from an employment. Class 1 NICs, unlike tax, are worked out separately for each earnings period (which is generally the pay interval) without taking account of previous earnings in the tax year. The exception to this is company directors, who are deemed to have an annual earnings period.
Primary contributions are payable by employees aged over 16 and under state pension age. They are the mechanism by which an employee builds up entitlement to the state pension and certain contributory benefits. An individual needs 35 qualifying years for the full single tier state pension, and at least ten qualifying years for a reduced state pension.
The starting point for employee contributions is the lower earnings limit, set at £120 per week (£520 per month; £6,240 per year) for 2020/21. However, while liability starts once earnings reach this level, contributions are payable at a notional zero rate until earnings exceed the primary threshold. This enables employees with earnings between the lower earnings limit and the primary threshold to build up a qualifying year without actually paying any NICs.
Once earnings reach the primary threshold, contributions are payable on earnings above the primary threshold up to the upper earnings limit at the main rate of 12%. Contributions are payable at the additional rate of 2% on earnings in excess of the upper earnings limit.
The government had previously announced their intention to bring the starting point at which employees start paying NICs in line with that at which they start paying tax. As part of that journey, the primary threshold is increased ahead of inflation to £183 per week (£792 per month; £9,500 per year) for 2020/21. However, the upper earnings limit remains unchanged at £962 per week (£4,167 per month; £50,000 per year) for 2020/21.
Employers pay secondary Class 1 NICs on earnings from their employees to the extent that they are above the secondary threshold. Where the employee is over 21, the liability starts once earnings reach the secondary threshold. For 2020/21, the primary and secondary thresholds are not aligned, and the secondary threshold is set at the lower level of £169 per week (£732 per month; £8,788 per year). Liability for secondary contributions is payable at the secondary rate of 13.8%. It does not stop when the employee reaches state pension age, and there is no equivalent of the upper earnings limit for employer contributions, meaning that they are payable on all earnings over the relevant threshold at the secondary rate of 13.8%.
Where the employee is under the age of 21, liability for secondary contributions does not kick in until earnings exceed the upper secondary threshold for under 21s, which remains at £962 per week (£4,167 per month; £50,000 per year) for 2020/21. Contributions are payable at a zero rate on earnings between the secondary threshold and upper secondary threshold for under 21s.
The position for employees aged under 21 is mirrored for apprentices under 25, and secondary contributions are only payable on earnings in excess of the apprentice upper secondary threshold, set at £962 per week (£4,167 per month; £50,000 per year) for 2020/21.
However, employees under 21 and apprentices under 25 pay primary contributions on earnings above the primary threshold as for other employees.
Employers also pay Class 1A (employer-only) NICs on taxable benefits-in-kind. From 6 April 2020, the Class 1A NICs liability also applies to taxable termination payments in excess of the £30,000 tax-free threshold and on taxable sporting testimonial payments in excess of £100,000. However, these are notified to HMRC under RTI rather than on form P11D(b), and are payable with the tax and Class 1 NICs for that month rather than in July after the end of the tax year.
Class 1B NICs are payable by employers in place of the Class 1 or Class 1A NICs liability that would otherwise arise on items included within a PAYE settlement agreement, and also on the tax due under that agreement.
The rate of Class 1A and Class 1B NICs mirrors that for secondary Class 1 NICs, being set at 13.8% for 2020/21.
For 2020/21, the employment allowance is increased to £4,000; but it is only available where the employer’s total secondary Class 1 NICs liability for 2019/20 was less than £100,000.
The self-employed
The self-employed continue to pay Class 2 and Class 4 NICs for 2020/21.
Class 2 NICs, which are weekly flat rate contributions payable for each week of self-employment, are the mechanism by which the self-employment earn entitlement to the state pension and certain contributory benefits. For 2020/21, the weekly rate of Class 2 NICs is £3.05 per week payable where profits exceed the small profits threshold, set at £6,475. Where a self-employed person has profits below the small profits threshold, they are entitled, but not required, to pay Class 2 NICs. Paying Class 2 NICs voluntary can be a cheap way to build up qualifying years where a person does not have the 35 qualifying years needed for the full single tier state pension.
Class 4 NICs offer no benefit or pension entitlement and operate like an additional tax on profit. Class 4 NICs are payable at the main rate of 9% on profits between the lower profits threshold and the upper profits threshold, and at 2% on profits above the upper profits threshold. The lower profits threshold is set at £9,500 for 2020/21 and aligned with the annual primary threshold for Class 1 NICs purposes, and the upper profits threshold is set at £50,000 for 2020/21 and aligned with the annual upper earning limit for Class 1 NICs purposes, bringing an element of parity between the employed and the self-employed.
Class 2 and Class 4 NICs are collected via the self-assessment system and are payable by 31 January after the end of the tax year to which they relate. Class 4 NICs are taken into account in working out payments on account, but Class 2 NICs are not.
Voluntary contributions
Class 3 NICs are voluntary contributions, which can be paid where an individual wishes to boost their contributions record.
However, at £15.30 per week for 2020/21 they are quite expensive, and where Class 2 NICs can be paid voluntarily instead, this is a much cheaper option.
Example: Comparison: employed vs self-employed
Jane is self-employed and has profits from her catering business of £66,000 for 2020/21. Her sister Julie works for an advertising agency and has earnings of £66,000 in 2020/21, payable as a salary of £5,500 per month.
Jane pays Class 2 NICs of £3.05 per week, a total of £158.60 for 2020/21.
Jane also pays Class 4 NICs of £3,965 (i.e. (9% (£50,000 - £9,500)) + (2% (£66,000 - £50,000))).
Jane pays total contributions of £4,123.60 for 2020/21.
Julie pays primary Class 1 NICs of £431.66 per month (i.e. (12% (£4,167 - £792)) + (2% (£5,500 - £4,167))) – equivalent to £5,179.92 per year.
Her employer also pays secondary Class 1 NICs of £657.98 per month (£7,895.76 per year).
So, although Jane and Julie have the same level of earnings for 2020/21, Julie pays additional contributions of £1,056.32. This reflects the greater benefit entitlement conferred by the payment of Class 1 NICs. Julie’s employer also pays a further £7,895.
Increases ahead?
It is likely that changes to both the rates and possibly the structure of NICs are on the agenda, as the Coronavirus Act 2020 makes provision for the 0.25% cap on contribution rises to be lifted for a two-year period.
Chancellor Rishi Sunak also hinted at possible changes ahead.
Practical tip
Where Class 2 NICs can be paid voluntarily to boost the number of qualifying years, this should be considered.
