All employees between the ages of 16 and state retirement age (65 for men and 60 for women) pay Class 1 National Insurance contributions on their earnings. It kicks in on all earnings above £110 per week or £476 per month and is charged at 11% up to £844 per week or £3,657 per month (2009/10 thresholds). Above this threshold it is charged at 1%. These rates are due to go up to 11.5% and 1.5% in April 2011.These contributions count towards a limited number of social security benefits such as State Pension, Jobseekers Allowance and Incapacity Benefit. All earnings between £95 and £110 per week count towards your NI record even though you do not actually pay contributions on them. However, at the other end of the scale, earnings above £844 per week do not count towards your NI record even though you pay 1% on them.
It is a common misconception that your NI contributions go towards your own state pension. In fact the State Pension is an unfunded scheme in the sense that contributions are not invested in your own pension plan but are used to pay the pensions of people who are already retired. Your own pension will (hopefully) be paid from the NI contributions of people who are still working when you are retired. Nonetheless, the state pension you receive will be based partially on earnings during your own working life and accrues at different rates between various bands of income.
You can reduce your NI contributions slightly by being a member of your employer's contracted-out money purchase occupational pension scheme. This means that your NI contributions will be reduced to 9.4% up to £770 per week (2009/10 threshold) and each year the Government will top up your employer's occupational scheme in place of S2P benefits. However, you should discuss your pension with a financial advisor before doing this as contracting-out is not always beneficial.
In normal circumstances Class 1 and/or Class 4 NI should not be charged at the full rate on any of your earnings above £43,875 per annum (2009/10 threshold). However, if you have more than one job or you are both employed and self-employed, it is possible for this to happen. Should that be the case you can apply for a refund from HM Revenue & Customs at the end of the tax year. You can also apply for a Deferment Certificate in respect of one or more employments by completing Form CA72A. The Revenue will then instruct your employer to deduct Class 1 NI at only 1% instead, and this should prevent you paying too much over the whole year. You can also apply for deferment of Class 2 and Class 4 NI by completing Form CA72B. However, should you end up paying too little NI, the Revenue will ask you to pay the shortfall at the end of the tax year.
At the other end of the scale, you may earn less than £110 per week (2009/10 threshold) in more than one employment. In that case, you will benefit from the Primary Threshold in each employment, so that even though your total earnings over the year may be well above the annual equivalent of £5,715 you will not pay NI in any of your jobs. For example, it is possible to have 6 jobs each paying £110 per week and your total earnings for the year would be £34,320 but you would not pay a penny in NI, even though each job counts towards your NI record. However, it is necessary for all the jobs to be totally unrelated. You cannot do it by working for different employers all controlled by the same person(s).
Students and others with irregular earnings may lose out because they only work a small number of weeks each year. For example, a student may work for 8 weeks in the summer and earn £250 per week. This is above the Primary Threshold of £110 for 2009/10 so his weekly NI contributions would be £15.40 (11% of £140). Over a year he would pay NI of £123.20 on total earnings of £2,000 which is well below the annual equivalent of the Primary Threshold. Unfortunately he would not be entitled to a refund although the contributions would count towards his NI record.
Directors pay their NI contributions in a different way to regular employees. As many directors are able to take their salaries as and when they want them rather than in equal weekly or monthly instalments, theoretically they can manipulate them in such a way as to avoid NI. For example, without these rules a director could take his annual £30,000 salary in one week, thus paying 11% on just £734 and 1% on 29,156 (2009/10 thresholds). Therefore, NI is calculated for directors on an annual cumulative basis. There is no NI on the first £5,715 of their earnings, the next £38,160 would be charged at 11% and the balance at 1% (2009/10 thresholds). Therefore they usually pay less NI than a regular employee on the same earnings for the first month or two but then pay more for most of the year and less for the last few months. Over a year the NI contributions are usually the same although a director may end up paying more than a regular employee in certain situations, such as where a large bonus is paid and total earnings for that month exceed £3,657. If total earnings for the year are less than £43,875 the director will pay 11% on the whole amount above the Primary Threshold whereas the regular employee will benefit from the 1% rate on some of the bonus. It should also be noted that the cumulative NI thresholds are adjusted pro-rata where a director is appointed during the tax year or terminates his appointment before the end of the tax year.