Why the Government may look at National Insurance again - Gareth Shaw

Dear Gareth,

I have been on a zero-hours contract since 2014 but earn the majority of my income over the Summer months. I am paid via Pay As You Earn (PAYE) on a monthly basis, with National Insurance contributions deducted and it is the monthly threshold that is applied each month, irrespective of how much I earn per year.

The result is that, because my contributions are deducted monthly when my earnings are not the same each month, the total paid in contributions is far higher than 12% of my annual earnings above the annual threshold.

Does HM Revenue and Customs (HMRC) owe me money? Why is it taking more than it should?

Mary Fawcett, via email.

Gareth says…

On paper, this does seem to be unjust. You sent me evidence of your earnings and I can see why you’re challenging it – last year, paying 12% over the annual earnings threshold for National Insurance would have meant paying almost £120; instead you ended up paying £460, 45% of the amount of earnings liable to National Insurance.

The point at which you pay National Insurance has been in the news for the past week, as the Chancellor Rishi Sunak announced in last Wednesday’s Budget that the amount you can earn before you pay any National Insurance is rising.

From 6 April 2020, you’ll pay 12% on the amount you earn between £9,500 and £50,000, if you’re an employee. If you’re self-employed, you’ll pay 9%. Anything you earn above £50,000 is taxed at 2%. This should amount to an annual tax saving of £104 for employees, and £78 for the self-employed.

The Conservative government aims to keep raising the National Insurance earnings threshold until it matches that of the personal tax-free allowance for income tax, which is currently £12,500 (and will remain at this level for the 2020/21 tax year).

A parallel with income tax is useful to draw when answering your question, but I’m afraid it’s not good news. Income tax is calculated on what’s known as a ‘cumulative’ basis – that is, all of your income for each month of the year is added together and you pay 20% tax on the amount you earn between £12,500 and £50,000, 40% on earnings between £50,000 and £150,000, and 45% on earnings above £150,000.

Rates of taxation are slightly different in Scotland, where income over £12,500 to £14,549 is taxed at 19%; £14,549 to £24,944 is taxed at 20%; £24,944 to £43,430 is taxed at 21%; £43,430 to £150,000 is taxed at 41% and income above £150,000 is taxed at 46%.

I spoke to HMRC about your query and shared some information about your earnings over the past three tax years, and the tax department’s deductions for National Insurance are correct – I’m afraid to say you will not be able to secure a refund, and you have not overpaid contributions.

This is because National Insurance, unlike income tax, is deducted on a ‘non-cumulative’, ‘non-aggregated’ basis. HMRC told me that National Insurance contributions are paid by individuals on earnings in an earnings period. Your earnings period is monthly, therefore you pay 12% on earnings above the monthly ‘primary threshold’, which is currently £719, and will increase to £792 from 6 April.

So, rather than basing the calculation of your National Insurance over the course of a year, the amount you pay depends on the frequency of your pay periods and the level of your earnings in each of those periods.

Why is this the case? Well, it’s partly historic – National Insurance was initially set up, HMRC told me, to fund the social security payments of the United Kingdom and the National Health Service and the fundamental principles of the system have not changed since its introduction.

The government has been urged to make changes to the system. The Office for Tax Simplification, a body that reviews the UK’s tax system, recommended that National Insurance be moved into a cumulative system, estimating that 7.6 million people would be better off as a result. Of course, for there to be some winners from such a change there has to be some losers – 5.5 million people would pay more National Insurance by changing the system.

I wish I had better news to pass on. The current government may well choose to look at National Insurance during this Parliament. But it remains to be seen as to what any changes might look like.

Gareth Shaw is Head of Money at Which?.