National Insurance Contributions

National Insurance contributions are paid to build an entitlement to a number of state benefits, particularly the State Pension. Other benefits which depend on your contribution record are the contribution-based Jobseeker’s Allowance, Bereavement Allowance and contribution-based Employment and Support Allowance. They are also applicable to Maternity Allowance and Incapacity Benefit.

The scheme was first introduced in 1911 and has been repeatedly amended since then.
Mandatory contributions are paid both directly by employees and by employers on their behalf. Self-employed workers contribute through a fixed regular payment in addition to a percentage of their net profits once those reach a certain level.

Over the years, the National Insurance has become a significant contribution to government revenue: in 2010/2011, this amounted to 21.5% of the total collected, or £96.5 billion.

All contributors have a personal National Insurance number, which identifies them uniquely and is used to claim benefits.

Sliding Scale

Contributions are paid on a sliding scale and fall into different classes.

Class 1 contributions are paid by employees and their employees. Those who earn between £139 and £817 per week pay 12% of the amount earned above £139. On incomes above £817 per week, an additional 2% of the excess is also paid. These contributions are deducted from wages by the employer.

Class 2 and Class 4 National Insurance contributions are paid by self-employed workers.
Class 2 contributions are paid at a flat rate of £2.50 per week while Class 4 contributions are a percentage of annual taxable profits. For profits between £7,225 and £42,475 a contribution of 9 per cent is paid and a further 2 per cent on profit which exceeds that figure.

Self-employed contributors whose profits are expected to fall below £5,315 may be exempt from Class 2 National Insurance contributions.

The lower earnings limit for Class 1 National Insurance contributions increased in 2011/12 to £139 from £110 in the previous year, with the upper limit being decreased from £844 to £817.

NI Tax Code

The rates at which contributions are paid by a worker and their employer vary on the basis of a number of factors. HMRC uses an alphabetic code known as the NI Table Letter to each possible combination of rates. The determination of rates is complex and the HMRC publishes a set of tables for each table letter to assist with this. Fortunately computers have taken much of the difficulty out of calculating rates.

It is important for employees who are working for more than one employer to ensure that they are not overpaying national Insurance. In such a case it is possible to defer contributions from one employer to prevent the overpayment.

Contributors who have a break in their National Insurance contributions may need to top up with voluntary contributions. These may be paid for any of the six years prior to the year of payment, although in some circumstances concessions may apply for other years.

Thirty qualifying years of contributions must be paid in order to receive the full Basic State Pension. Proportionally lower rates of pension are applicable to a shorter qualifying period.

Student Loans and Income Tax

Repayment of your student loan is usually automatic if you are working within the UK and earning more than £15,000 annually. The repayment will be deducted from your salary along with your tax and you will be notified of this by the Student Loans Company.

Your first repayment will occur at the beginning of the tax year following the end of your course. The rate of repayment will be 9% of any money you earn above the £15,000. If your salary is less than £15,000, you will not pay anything. The interest rate if lower than that charged by banks or building societies and it will be automatically calculated.

If you choose to pay off your loan more quickly, you may make additional voluntary payments directly to the Student Loans Company at any time. You will also need to make payments direct to the Student Loans Company if you are working abroad.

Self Employment, Student Loans and Income tax

If you’re self-employed, your repayments will be calculated after you submit your annual tax return.

It may be complicated to decide whether you should make accelerated payments on your student loan in order to clear the debt more quickly.

When making this decision, it’s important to realize that there’s no great advantage in paying the loan off early. If you lose your job or have other financial problems, payments will be waived until your income is again above the threshold.

There’s a tendency to think that slow payment means the accrual of interest, but in fact the interest is pegged only at the rate of inflation, so in real terms there will be no increase in the total due.

The other factor affecting the decision is that student loans, unlike other debts, are eventually written off. The exact life on the loan depends on the type of loan you have, but it will eventually be written off, most commonly either 25 or 35 years after you graduated. This means that there’s a definite financial advantage in paying off any other loans or mortgages you have which will inevitably have a higher interest rate.

Low Interest

Look at it this way: you’re lucky enough to have a substantial loan at very low interest: instead of paying, say £5,000 off the loan when you have some spare cash, you’d be better off putting it into an interest-bearing deposit account. The accrual of capital over a few years will almost certainly outstrip the growth in your total debt to the Student Loan Company, making eventual repayment less painful.

This is only an overview, and the actual details of your loan repayment will vary according to which type of loan you have. It’s easy to find calculators for student loan repayments online and work out exactly how much you owe and how much it’s costing you. Armed with that information you can make a better choice about how to handle loan repayments.

The one thing that is certain is that if you have an outstanding student loan and you’re earning more than £15,000 in the UK, HM Revenue and Customs will be there to take repayments out of your pay packet.

Income Tax Bands

The overarching philosophy of UK income tax is that it should operate on a sliding scale, in which the rate of taxation increases progressively as income increases. This conforms to the more or less socialist principle that people who earn more should contribute more to the costs of administering the society, making HM Revenue and Customs a modern day, institutionalised Robin Hood.

In practice this is organised by dividing taxpayers into four bands according to income and taxing each of them at a different rate.

The lowest band, the Lower Rate, for people with an income of less than £7,475 (in the current tax year) pay no tax on earned income.

The next band, the Basic Rate band, includes incomes up to £35,000 per year and attracts a tax rate of 20%.

The Higher rate covers incomes from £35,001 to £150,000 and tax is payable on this band at 40%.

The Additional Rate, introduced in the 2010/11 tax year, covers taxpayers with an income in excess of £150,000 and tax is payable at the rate of 50%.

Simplified Income Tax Bands?

Sounds simple? Of course it’s not. There are a number of additional refinements and a complex system of income tax allowances which permit a myriad of adjustments to the final tax paid.

First, it’s important to realise that each band does not include income falling into the band below. Thus, for instance, a taxpayer in the Higher Rate band will pay the higher rate, 40% only on the amount of income greater than £35,000, the bottom income limit of the band. The first £35,000 will attract the basic rate of 20%.

The Income Tax Allowance system further complicates the issue. All taxpayers under the age of 65 with an adjusted net income below £100,000 are given a personal allowance of £7,475 on which no tax is paid. There are a number of additional allowances which may be added to this in particular circumstances.

Added to the system of bands and allowances are a number of defined exemptions, sources of income which are exempt from tax or on which tax is paid at rate other than that applying to the taxpayer’s band.

From the age of 65, the situation changes: the Personal Allowance increases in two steps, one on reaching 65 and the second on reaching 75, but the adjusted net income ceiling to which the personal and other allowances are subject is severely lowered.

Tax Bands in Practice

How does it work in practice? Complicated as the system is, the basic calculation is surprisingly straightforward.

First take the gross income and deduct any allowances to which you are entitled to arrive at the adjusted net income. This is the basic figure to which income tax is applied. The first part of this income, that which falls into the lower rate band, is then taxed at the lower rate. Then take the amount of income falling into the basic rate band: this is taxed at the basic rate of 20%. Then the amount of income between £35,000 and £150,000, the higher rate band, is taxed at 40%. Anything over £150,000 is then taxed at the new additional rate of 50%.

Of course, some might argue, if you’re in this last income band you’re obviously close to Bad King John and HM Revenue and Customs will feel free to tax you at any level they feel like on any other income you may enjoy. 

Add your own comments or questions on the thorny subject of income tax bands..

Employer’s National Insurance Contributions

Employers are obliged to pay National Insurance contributions on both the salaries and benefits paid to their employees. Benefits which make up part of earnings and are liable to contributions may include the provision of company cars and medical insurance.

The employer is responsible for deducting both income tax and National Insurance contributions from salaries paid to employees. The deductions are disbursed each month to HM Revenue and customs. Apart from the employee’s own contributions, the employer pays the employer National Insurance contribution, a cost to the employer over and above the gross salary paid to the employee.

There are six classes of NICs. Class 1 are paid by individuals through the employer and by employers themselves, Class 2 by self-employed individuals, Class 3 are voluntary contributions by individuals and Class 4 are paid by self-employed individuals as a percentage of profit.

The classes which apply to employers are Class 1A and Class 1B 

Class 1. These payments are collected by the employer and paid through the PAYE system. The employer contribution is calculated as a percentage of employee earnings over a certain amount. It is also applied to a number of benefits provided to employees. There are a vast number of Class 1 categories applying to employees in various circumstances. A special calculation applies to directors.

Class 1A. These payments are paid by employers and others on benefits provided to employees.

Class 1B contributions are paid by employers who have agreed on a PAYE Settlement Agreement with HM Revenue and Customs. They are calculated on the combined value of the items covered by the agreement and the tax payable by the employer under that agreement. These contributions are paid at the same rate as Class 1A but do not provide any benefit entitlement to individual employees.

Employers National Insurance Contributions Calculation and Filing

Within each class there are numerous categories of contributions and the rates for these are published in electronic table form by HMRC.

The employer is responsible for allocating the correct table to each employee depending on a number of criteria. The rate payable by employer and employee is defined by the appropriate table.

The main responsibility of the employer is to deduct employee Class 1 contributions through the payroll, to pay employer Class 1A contributions following the end of the tax year on benefits provided to employees and, if a PAYE Settlement Agreement has been signed, to pay employer Class 1B contributions after the end of the tax year.

The system has been streamlined in recent years with the introduction of PAYE Online. Most filing with the HMRC can be done via this system.

In addition to the responsibilities outlined above, almost all employers are required to file and Employer Annual Return online. Online forms must also be filed when an employee enters or leaves employment, when a new employee begins but has no P45 form from a previous employer, when the employer begins paying a new pension or annuity and for filing details of certain categories of employees seconded to work in the UK.