How to avoid confusion over National Insurance payments - Gareth Shaw

Dear Gareth,

I’m currently a contractor in the television industry and have always been paid through the Pay As You Earn system for the period in which I’m working for a particular studio, so I’ve never had to worry about paying my taxes.

However, I was one of the many excluded freelancers who could not access the government self-employed or furlough schemes during the pandemic because I could not prove that my income came from self-employment, nor was I an employee of the companies I work for.

I’ve decided to set up as a sole trader now, and I’m pretty sure I know my way around completing my tax return – I’ve got a unique taxpayer reference number and am set up on gov.uk.

But I’m really confused about National Insurance From what I have read, there seems to be two types that I need to pay? Can you please explain?

Anonymous, via email.

Gareth says…

This is a really good question. When you’re paid through the Pay As You Earn system (which means tax is deducted by your employer before you receive your pay), you may not pay all that much attention to your payslip, and what’s being taken off your pay packet.

But when you have responsibility for ensuring you can pay your taxes, you need to know exactly where your money is going.

National Insurance is a tax on your earnings and/or profits. The contributions you make are paid into a fund, from which many state benefits are paid, including the state pension, unemployment benefits and maternity allowance. Crucially, building up years worth of National Insurance ensures that you are entitled to claim some benefits – in order to get any state pension, for example, you need a minimum of 10 years’ worth of National Insurance contributions. To get the full amount, you need 35 years’ worth.

National Insurance is paid by employees and the self-employed on earned income until you reach state pension age. And just to add an extra layer of confusion, there are potentially three different types – known as ‘classes’ – that a self-employed person could pay.

Which ones you pay, and how much you pay, will depend how much profit you make during the tax year. Most self-employed people pay Class 2 contributions and Class 4 contributions.

Class 2 contributions are a fixed weekly amount, which is only payable if your profits exceed £6,515 in the current 2021/22 tax year. You pay £3.05 per week, equivalent to £158.60 per year.

Even if you earn less than this amount, you may elect to pay Class 2 contributions anyway, to ensure that you don’t have any gaps in your National Insurance record and qualify for the full state pension.

Class 4 contributions are charged as a percentage of your profits over a certain amount. You’re charged 9% on profits between £9,568 and £50,270, and 2% on anything above £50,270. This puts you at an advantage compared to employees, who pay 11% on income between £9,568 and £50,270.

If your profits exceed £9,568, you will pay both classes.

There has been speculation that the self-employed will lose this tax advantage in the future, as a result of the pandemic. When the Chancellor of the Exchequer, Rishi Sunak, announced the self-employed income support grant in March last year, he said that ‘If we all want to benefit equally from state support we must all pay in equally in future”, suggesting that he planned to equalise the rates payable by both the employed and the self-employed.

If you have any gaps in your National Insurance record, you could also pay voluntary Class 3 contributions, though the rate tends to be higher and you may not qualify for certain benefits. The benefit, however, is that you can backdate gaps for the past six years.

Which? has published a National Insurance calculator that the self-employed can use to get an idea of what they might pay based on their forecasted profits.

Visit which.co.uk/nicalc to use it.

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