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National Insurance
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National Insurance (NI) is a system of taxes and related social security benefits in the United Kingdom. It was first introduced by the National Insurance Act 1908, and expanded by the government of Clement Attlee in 1946. The tax component of the system consists of taxes paid by employees and employers on earnings, and by employers on certain other benefits-in-kind provided to employees. The self-employed are taxed based upon profits. Such taxes are said to be National Insurance Contributions (NICs).
The benefit component of the system is a number of contributory benefits, these are ones where the claimant's previous contribution record determines the availability and amount of the benefit paid.
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National Insurance (NI) is a system of taxes and related social security benefits in the United Kingdom. It was first introduced by the National Insurance Act 1908, and expanded by the government of Clement Attlee in 1946. The tax component of the system consists of taxes paid by employees and employers on earnings, and by employers on certain other benefits-in-kind provided to employees. The self-employed are taxed based upon profits. Such taxes are said to be National Insurance Contributions (NICs).
The benefit component of the system is a number of contributory benefits, these are ones where the claimant's previous contribution record determines the availability and amount of the benefit paid. The benefits provided are weekly income benefits and some lump sum benefits to participants upon death, retirement, unemployment, maternity and disability.
History
The name national insurance was adopted as an expression of the government's aspiration that the system should be qualitatively different from conventional general taxation such as income tax.
The proposed differences that were enacted, or aspired to, included:
- the revenue was expected to roughly equate to current spending on contributory benefits
- no means testing of benefits - the amount of benefit paid in respect of any claim by a claimant was the same whether the claimant was rich or poor, depending only on the completeness of the claimant's contribution record
- a cap on the system's scope for redistribution - above a certain level of earnings or profits no extra contributions were payable
- the payment of a contribution by an employer for each employee comparable to that paid by the employee
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, like 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. 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.
NI has been criticised as a "stealth tax" and "an income tax in everything but name": in recent years governments have trumpeted the fact that income tax rates have not changed, while they have increased revenue by increasing the rates and scope of NI. At the same time the unfairness of a tax that is levied on the wage income of all workers but not on dividend or interest income has been criticised: at the extreme this leads to the contrast between a low-paid worker who has to pay the tax on his income and a wealthy owner of income-bearing assets who does not.
There have been proposals put forward by think-tanks to abolish employees' National Insurance altogether by rolling it up into income tax; these have yet to be adopted as a policy by a major political party.
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 for ease of understanding they are referred to simply as employee and employer contributions in this article.
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 before remitting the money 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 bend - 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 11th 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 2007 budget, the then Chancellor of the Exchequer Gordon Brown announced that in future the LEL and UEL would be aligned with the income tax basic rate band. This aim is currently scheduled to be achieved by April 2011.
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/employer 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.
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. The main reason for paying Class 3 NICs is to ensure that a person's contribution record is preserved to provide entitlement to the state pension. Generally a woman currently needs 10 years of contributions and a man 11 years for a minimum state pension. In certain cases (e.g. parents and carers) fewer years may be 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. 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 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
People born and resident in the UK are assigned an NI number (referred to internally as a NINO), and receive a plastic card of similar proportions to a credit card with the number raised on the front shortly before their 16th birthday, and are advised to keep the card safe (only one replacement card may ever be issued over the lifetime of an individual). However, allocation of this number might occur a long time before this occasion (the date can usually be established from the prefix letters used), and siblings may have consecutive numbers - this is dependent on the payment of Child Benefit.
Persons from abroad looking to work in the UK, or those to whom a number was not initially allocated as children, may apply for a number through the Department for Work and Pensions (DWP). The prefixes used are typically different from those used in the normal run.
The format of the number is two letters, six digits, and one optional letter. 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).
In the case of AB 12 34 56 C, the first and second letter cannot be D, F, I, Q, U and V. The second letter also cannot be O. The first two character combinations BG, GB, NK, KN, TN, NT and ZZ are not used. The six digits are sequentially issued (siblings who are few years apart may notice their numbers are consecutive when the numbers are issued together), and the suffix letter is A, B, C, D or absent. The number is unique without the last letter - if there is AB 12 34 56 C, then there will be no AB 12 34 56 D (though it is possible that there will be AB 12 34 57 D). A common error found on documents containing an individual's NI number is the final letter being incorrect, though this error is non-fatal in that an individual can be identified without the last letter.
It is worth noting that, while an individual may be issued with a second NI number when all traces of their original number has been lost, these numbers never change. Some accountants often mistakenly advise their customers of a change, particularly in the suffix letter, where A referred to employment, B to self-employment, etc. The actual meaning of the suffix letter dates back to before NIRS (see below), and referred to the quarter in which that individual's annual record card was due for return, and is roughly (but not directly) linked to their date of birth.
As the UK does not, as yet, have a system of personal ID cards, and not everyone has a passport, the NI number is, along with the NHS number, one of only two systems which provide every adult in the country with a code number. Consequently, NI numbers are sometimes used for identification purposes in other contexts which have nothing to do with their original National Insurance purpose. This is despite a clear claim on the back of the NI card, and a smaller claim on the front, that it is not proof of identity.
In the past, employers sometimes allocated their employees a temporary insurance number, which followed the format TN 01 23 45 X, where 'TN' stands for temporary number and is static and X is usually M for male in the case of men or F for female in the case of women and the numbers in the mid-section are the employee's date of birth. In the case of a woman born on 1st December 1958, for example, the temporary NI number would most likely be TN 01 12 58 F. This has now changed slightly in that the TN prefix is no longer used. Temporary NI numbers cannot be used to trace back any NI credits/ personal details. HMRC now discourages the use of these numbers.
Another type of temporary NI number is the Revenue issued "temporary reference" used when HMRC is unable to trace a taxpayer's original NI number. It follows the format 63T12345.
NIRS
National Insurance contributions for all UK residents and some non-residents are recorded using the NIRS computer software package (National Insurance Recording System, pronounced "nurse"). NIRS is currently in its second generation and is known within the Civil Service as NIRS/2 ("nurse two").
The original 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 is a Microsoft Windows based system with several applications under its umbrella. These include 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 has been some controversy regarding the NIRS/2 system from its inception in 1996 when problems with the new system attracted widespread media coverage. Due to these computer problems, deficiency notices which used to be sent out on an annual basis stopped being issued in 1996. The Inland Revenue is currently (as of August 2004) running an exercise to catch up on a backlog of deficiency notices for the 1996-97 to 2001-02 tax years on the instructions of the Paymaster General. The exercise is due for completion in March 2005. Deficiency notices are due to be issued on an annual basis again from October 2004.
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.
See also
External links
interactive tool on the Business Link website
, from UK government website Directgov
- The official UK government definition of the NI number format. Also includes links to the XML Schema data type definition in the CitizenIdentificationTypes schema published by the Office of the e-Envoy.
HM Revenue & Customs official page
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