National Insurance

National Insurance (NI) in the United Kingdom was initially a contributory system of insurance against illness and unemployment, and later also provided retirement pensions and other benefits. It was first introduced by the National Insurance Act 1911, and expanded by the government of Clement Attlee in 1946. It is currently the second largest source of tax, amounting to an addition 20% income tax at middle bracket incomes. HMRC provide an online National Insurance Calculator.

The contributions component of the system consists of mandatory contributions, National Insurance Contributions (NICs), paid by employees and employers on earnings, and by employers on certain benefits-in-kind provided to employees. The self-employed contribute, partly by a fixed, weekly or monthly payment, and partly on a percentage of net profits. Individuals may also make voluntary contributions, in order to fill a gap in their contributions record.

The benefit component comprises a number of contributory benefits of availability and amount determined by the claimant's contribution record. Weekly income benefits and some lump-sum benefits to participants upon death, retirement, unemployment, maternity and disability are provided.

History

Initially, the most important contributory benefits were the State Retirement Pension and Unemployment Benefit.

With the introduction of employer payroll tax deduction (Pay-As-You-Earn or PAYE), employees' National Insurance contributions were collected along with income tax. This replaced the old system of purchasing a contribution certificate or stamp, but for many years some older Britons continued to describe making NI contributions as paying their stamp.

As the system developed, the link between individual contributions and benefits was weakened. The National Insurance Fund is still nominally hypothecated, and national insurance payments cannot be used to fund general government spending, although as much of the fund is invested in government securities it is available for borrowing by the government for spending on capital projects, such as schools and hospitals. National Insurance contributions are paid into the various classes of National Insurance after deduction of monies specifically allocated to the National Health Service (NHS). However a small percentage is transferred from the fund to the NHS from certain of the smaller sub-classes. Thus the NHS is partially funded from NI contributions but not from the NI Fund.

Recent developments of the system have meant that National Insurance provides a significant part of the government's revenue (£90 billion in 2006-2007, approximately 17% of total government receipts). At the same time it has become more redistributive as its structure has changed to remove the fixed upper contribution limits, albeit with a much lower rate payable by employees on income above a certain level. It has been mooted that the link between individual's contribution record and the remaining contributory benefits will be weakened further.

In the early twenty-first century, governments sometimes announced that income tax rates had not increased, while increasing revenue by increasing the rates and scope of NI. The unfairness of a tax that is levied on the wage income of all workers but not on dividend or interest income has also been criticised: a low-paid worker must pay NI on his income, while a wealthy owner of income-bearing assets does not.

In the March 2011 Budget, the Chancellor announced a consultation on the operational integration of the NI contributions and income tax systems. However, the options to be considered do not include extension of NI contributions to other forms of income such as pensions, dividends and savings.

Contribution classes

National insurance contributions (NICs) fall into a number of classes. Class 1, 2 and 3 NICs paid are credited to an individual's NI account, which determines eligibility for certain benefits - including the state pension. Class 1A, 1B and 4 NIC do not count towards benefit entitlements but must still be paid if due.

Class 1

Class 1 contributions are paid by employers and their employees. In law, the employee contribution is referred to as the 'primary' contribution and the employer contribution as the 'secondary', but they are usually referred to simply as employee and employer contributions.

The employee contribution is deducted from gross wages by the employer, with no action required by the employee. The employer then adds in their own contribution and remits the total to HMRC along with income tax.

There are three milestone figures which determine the rate of NICs to be paid: Lower Earnings Limit (LEL), Earnings Threshold (ET) and Upper Earnings Limit (UEL). In this context "earnings" refers to an employee's wage or salary. The cash value of each of these limits changes each year, either in line with inflation or by some other amount decided by the Chancellor.

• Below the LEL, no NICs are paid because no benefits can accrue on earnings below this limit.
• On earnings above the LEL and below the ET, contributions are not paid but are credited by the government as if they were. This effectively assists the working poor to get benefits. Additionally, where the employee and employer contribute to certain types of occupational pension scheme, there is a negative contribution rate on earnings in this band - this 'rebate' can be offset against contributions in other earnings bands.
• On salaries between the ET and the UEL, NICs are collected at a rate which is determined by a number of factors:
  • The type of occupational pension scheme (if any) to which the employee and employer make contributions
  • Whether the employee has reached the age at which state retirement pension becomes payable
  • Whether the employee is a married woman paying reduced-rate contributions. This facility was abolished on 11 May 1977 but women who were already paying these contributions at that time were allowed to opt to continue to do so for as long as they remained married.
  • Whether the employee is an ocean-going mariner or deep-sea fisherman
• On the portion above the UEL there are again various rates, depending on similar factors to those relating to the previous earnings band, with the exception that the type of pension scheme no longer has a bearing.

Unlike income tax the limits for class 1 NICs for ordinary employees are calculated on a periodic basis, usually weekly or monthly depending on how the employee is paid. However those for company directors are always calculated on an annual basis, to ensure that the correct level of NICs are collected regardless of how often the director chooses to be paid.

In the March 2011 Budget, the Chancellor announced that in future, employee NI thresholds will be indexed to inflation using the CPI, while employer thresholds remain indexed using the RPI.

Table letters

As indicated above, the rates at which an individual and their employer pay contributions depend on a number of factors. Consequently there are many possible sets of employer/employee contribution rates to allow for all combinations of the various factors. HMRC allocate a letter of the alphabet, referred to as an 'NI Table Letter', to each of these sets of contribution rates. The complexity of the system is such that 21 of the 26 letters of the alphabet are currently in use for this purpose. Each tax year, HMRC publish look-up tables for each table letter to assist with manual calculation of contributions, though these days most of the calculations are done by computer systems.

Employers are responsible for allocating the correct table letter (sometimes also referred to as an 'NI category') to each employee depending on their particular circumstances. This then defines the rates of employee and employer contribution which apply.

Class 1A

Class 1A contributions are paid by employers on the value of company cars and certain other benefits in kind provided to their employees and directors, at a rate of 12.8% of the value of the benefits in kind (from their P11Ds).

Class 1B

Class 1B were introduced on 6 April 1999 and are payable whenever an employer enters into a PAYE Settlement Agreement (a PSA) for tax. Class 1B NICs are payable only by employers and payment does not provide any benefit entitlement for individuals.

Class 2

Class 2 contributions are fixed weekly amounts paid by the self-employed. They are due regardless of trading profits or losses, but people on small (low) earnings can apply for exception from paying and those on high earnings with liability to either Class 1 or 4 can apply for deferment from paying. While the amount is calculated to a weekly figure, they are typically paid monthly or quarterly. For the most part, unlike Class 1, they do not form part of a qualifying contribution record for contributions-based Jobseekers Allowance, but do count towards Employment and Support Allowance.

Class 3

Class 3 contributions are voluntary NICs paid by people that wish to fill a gap in their contributions record which has arisen either by not working or by their earnings being too low. Class 3 contributions only count towards State Pension and Bereavement Benefits entitlement. The main reason for paying Class 3 NICs is to ensure that a person's contribution record is preserved to provide entitlement to these benefits. Until 2010, a woman generally needed 9 years of contributions and a man 11 years for a minimum (25%) state pension. In certain cases (e.g. parents and carers) fewer years may be required. Since 2010, only one year of contributions (credited, or paid) has been required.

Class 4

Class 4 contributions are paid by self-employed people as a portion of their profits, calculated with income tax at the end of the year, based on figures supplied on the SA100 tax return. Below the earnings threshold no class 4 NICs are due. Above the earnings threshold and below the upper earnings limit class 4 NICs are paid at a rate of 8% of trading profits. Above the upper earnings limit class 4 NICs are paid at a rate of 1% of trading profits. They do not form part of a qualifying contribution record for any benefits, including the state retirement pension.

NIC credits

People who are unable to work for some reason may be able to claim NIC credits (technically credited earnings, since 1987). These are equivalent to Class 1 NICs, though are not paid for. They are granted either to maintain a contributions record while not working, or to those applying for benefits whose contribution record is only slightly short of the requirements for those benefits. In the latter case, they are unavailable to fill "gaps" in past years in contribution records for some benefits.

Actuarial reviews

An actuarial evaluation of the long-term prospects for the National Insurance system is mandated every 5 years, or whenever any changes are proposed to benefits or contributions. Such evaluations are conducted by the Government Actuary's Department and the resulting reports must be presented to the UK Parliament.

National Insurance number

Main article: National Insurance number

In order to administer the National Insurance system, a National Insurance number is allocated to every child in the United Kingdom shortly before their 16th birthday. A number is also given to younger children for whom Child Benefit is paid. People coming from overseas have to apply for an NI number before they can work in the UK. The number is in the format: two letters, six digits, and one further letter or a space. The example used is typically AB123456C. It is usual to pair off the digits - such separators are seen on forms used by government departments (both internal and external, notably the P45 and P60).

National Insurance and PAYE Service

National Insurance contributions for all UK residents and some non-residents are recorded using the NPS computer system (National Insurance and PAYE Service).

The original National Insurance Recording System (NIRS) was a more archaic system first used in 1975 without direct user access to its records. A civil servant working within the Contributions Office (NICO) would have to request paper printouts of an individual's account which could take up to two weeks to arrive. New information to be added to the account would be sent to specialised data entry operatives on paper to be input into NIRS.

NIRS/2, introduced in 1996, was a large and complex computer system which comprised several applications. These included individual applications to access or update an individual National Insurance account, to view employer's National Insurance schemes and a general work management application. There was some controversy regarding the NIRS/2 system from its inception when problems with the new system attracted widespread media coverage. Due to these computer problems, deficiency notices, which had been sent out on an annual basis prior to 1996, stopped being issued. The Inland Revenue took several years to clear the backlog.

In June 2009, HM Revenue & Customs created a new National Insurance and PAYE Service (NPS) to replace both NIRS/2 and the legacy PAYE system.

From April 2010 only 30 years' contributions will be required in order to receive the maximum state pension (age retirement) instead of the previously required 44 years for men and 39 years for women. Care should be taken when receiving a deficiency notice if due to reach retirement age after April 2010. However, the previous higher age limit still applies for claiming Bereavement Benefits.

See also

• National Insurance Fund
• Beveridge Report
• Regressive tax
• Swiss Social Insurance Template:De icon
• Swiss Social Insurance Template:Fr icon

External links

• National Insurance Contributions and Benefits
• HM Revenue and Customs
• What National Insurance contributions do I need to pay? interactive tool on the Business Link website
• Introduction to National Insurance, from UK government website Directgov
• Up to date national insurance rates tables
• UK NI Contribution Record Errors
• Benefits fiasco leaves millions out of pocket
• Widespread errors hit state pensions

• National Insurance Contribution Rates and Allowances