What is national insurance and how is it calculated?

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  • Amid the current cost of living crisis, understanding national insurance has never been more important. This is especially true as national insurance is due to rise as of April 2022, at the same time the energy price cap increase comes into effect.

    National insurance (NI), like income tax, is one of those deductions we’re mostly aware of as it impacts our take-home pay. But most of us probably don’t know the specifics around what it is, how it’s calculated or what we get for our money. “National Insurance is a tax that was introduced more than 100 years ago to provide a safety net for people who couldn’t work due to illness or unemployment”, says Sarah Pennells, consumer finance specialist with life and pension company Royal London. “You don’t pay it, if you’re on very low earnings, but otherwise you pay it if you’re an employee or self-employed.”

    What is national insurance in simple terms?

    National insurance is a tax on ‘earned income’ – so that’s money you get through paid work, not from anything you earn in the way of interest or profits on savings or investments. You pay NI, both as an employee, or if you’re self-employed, once your earnings go over certain minimum levels. If you’re sixteen or over, you must pay national insurance if you’re an employee who earns over £184 a week, (£9,568 a year), or are self-employed and turn a profit, (after expenses), of £6,515 or more a year.

    This threshold is due to increase from July 2022, following Chancellor Rishi Sunak’s Spring Statement. The new threshold for an employee will be £12,570 per year.

    Before you can start paying NI, you’ll need a national insurance number. This is your own unique number, with a combination of letters and numbers, which is sent to you by the Department for Work and Pensions. You get one for life, and it makes for an easy way for HMRC to track your tax and NI payments over the years, along with benefits and state pension entitlement.

    How is national insurance calculated?

    The rate of national insurance you pay, and the level at which payments start, will depend on whether you’re employed or work for yourself, and how much you earn or make in profits. The government has set out four different ‘classes’ of payments:

    Class 1 – you pay this if you’re employed

    If you earn less than £184 a week, (£9,568 in the current tax year), you won’t pay NI. After that, you will pay national insurance, but how much you pay will depend on how much you earn.

    “On the next chunk of pay, you’ll pay 12% on everything from £9,568 to £50,270 in the current tax year”, says Sarah Coles, personal finance analyst with investment firm Hargreaves Lansdown.

    “You’ll then pay a lower rate on the final chunk of your salary, from £50,270, which in the current tax year is 2%”.

    Class 2  – paid by anyone who is self-employed on profits of £9,568 a year or less

    If you’re self-employed, you’ll pay Class 2 and 4, which is calculated based on your profits.

    Profits of up to £6,515 are tax free, but for anything between £6,515-£9,568 you’ll pay Class 2 national insurance, which is currently £3.05 a week.

    After this, Class 4 kicks in, which we explain below.

    Class 3 – paid for voluntary contributions

    These are additional payments you can make on a voluntary basis to ‘top up’ any gaps in your national insurance record. Gaps can occur if, for example, you don’t pay NI because you’re on a low income. Making up any ‘missing’ payments can mean you’ll then qualify for the full state pension, as you need 35 years’ worth of payments to be eligible for this.

    Class 4 – paid by anyone who is self-employed on profits of £9,569 a year or more.

    You’ll pay 9% national insurance between £9,569 and £50,270 and above that you’ll pay a lower rate of 2%. These rates apply to the current tax year 2021/22. From 6 April 2022, when the new tax year kicks in, these will increase.

    What does national insurance pay for?

    NI contributions go towards funding a whole raft of payments and benefits. These include the State Pension along with benefits including Jobseeker’s Allowance, Maternity Allowance, Employment and Support Allowance and the Bereavement Support Payment. NI payments currently raise over £142 billion pounds a year for the Government, according to consumer research company Statista.

    In some cases, such as ‘contribution based’ Jobseeker’s Allowance, the amount you can get, (if you’re eligible to claim), can depend on the amount of national insurance you’ve paid. “However, this doesn’t mean your national insurance payments are actually ringfenced to pay your own pension and benefits”, warns Sarah Coles. “It goes into a national insurance fund and is used to pay people who need help today. In the years when it isn’t enough to meet the cost of these benefits, the Treasury makes up the shortfall”.

    In September 2021, the Government announced it will be increasing NI in order to raise an additional £12 billion for health and social care following the Covid pandemic. The increase will be in place for the 2022/23 tax year.

    Do you legally have to pay national insurance?

    Yes, there are no two ways about it – if your income tops the relevant threshold, you must pay national insurance. If you’re employed, this will be done automatically through the Pay as you Earn (PAYE) system. This means that both NI and income tax will be taken off your gross salary by your employer, before reaching your bank account.

    If you’re self-employed and fill in a self-assessment tax return, then HMRC will work out how much national insurance and tax you need to pay. As part of the process, they’ll let you know how much you owe, when it’s due and how to pay.

    If you’re still working later in life, you won’t have to pay NI if you work beyond state pension age. But you may still be liable for income tax if your earnings and income from other sources top your annual tax-free allowance of £12,570.