Who has to pay national insurance contributions?
Contractors, like most other UK workers, may be liable to pay National Insurance Contributions (NICs) when earning above a certain threshold.
Most limited company contractors working outside IR35 pay little or no NICs because they pay themselves a low salary and a high dividend from company profits. However, all umbrella company contractors, contractors on the agency payroll and those on fixed-term employment contracts do.
Unlike income tax, NICs are only applied to a contractor’s employment earnings, or self-employment profits, within a certain band. Those earning below the band pay nothing, and those earning above pay a reduced rate.
Another major element of NICs, and how this tax differs from income tax, is that both employers and employees pay them. Because NICs are often labelled as a ‘tax on jobs’, measures are planned so that in the 2014/2015 tax year, all companies will benefit from an exemption from paying the first £2,000 of their employers NICs.
What are National Insurance Contributions?
Technically, national insurance contributions (NICs) are not a tax. When introduced in 1911, NICs were designed to provide a safety net for workers when they became ill or unemployed, hence the name. The scheme grew to include pensions and other benefits, and expanded significantly in 1948 with the introduction of the welfare state.
Although not a tax, NICs are collected by HMRC mainly through Pay As You Earn (PAYE) taxation, at the same time as income tax is deducted. And despite not being a tax, NICs continue to contribute roughly a fifth of the income to the exchequer each year.
NICs have always worked on a contributory based principle, the theory being that a worker draws out what they put in during time of need.
In practice, the original principle has become diluted and, partially as a result, a complex set of bands and tiers have developed, with workers in theory required to make minimum payments in order that they qualify for specific benefits.
HMRC also collects employers NICs from both employers and employees, so limited company contractors who pay NICs will see deductions from their pay, as well as having to make payments from their companies.
How are national insurance contributions for employees calculated?
All employees and the self-employed pay NICs if their earnings are above a particular threshold and until they reach state retirement age. Because the vast majority of contractors are employed, either by their own limited company, an umbrella company or an agency, they pay Class 1 National Insurance Contributions.
All umbrella company contractors, contractors on the agency payroll and those on fixed-term employment contract pay NICs
Class 1 NICs rates for the 2013/14 tax year are calculated as follows:
- 12% on earnings between what is known as the lower limit, £149 per week/£7,748 per year and what is known as the upper limit, £797 per week/£41,444
- 2% on all earnings over the upper limit, or £797 per week/£41,444 per year.
The starting threshold, or lower earnings limit, for NICs is considerably lower than the income tax personal allowance, so limited company contractors paying themselves a minimum salary and dividends may still be liable for a small amount of national insurance and should consider this when calculating how much they want to earn.
Example of employee NICs: contractor earning £60,000 per year
For an employed contractor taking their salary via PAYE and earning £60,000 per year, using Contractor Calculator’s PAYE-NI Net Salary Tax Calculator, the NIC calculation is as follows:
- Earnings up to £7,748 per year do not attract NICs
- For earnings between £7,748 and £41,444 the 12% rate is applied. £41,444 - £7,448 = £33,696, and 12% of £33,696 = £4,043.52
- The 2% rate applies to earnings from £41,444 to £60,000. When you subtract £41,444 from £60,000, you get £18,556, and 2% of £18,556 is £371.12
- The total employees NICs payable by a contractor on a salary of £60,000 per year would be £4,414.
The table below highlights how the band rates are applied to contractor’s earnings:
|Rate below upper earnings limit
|Rate above upper earnings limit
The NIC calculation differs from the income tax calculation because NICs apply to specific income bands, and not to cumulative allowances.
How are employers NICs calculated?
Another major difference between income tax and NICs is that a contractor’s employer also has to calculate and pay NICs directly to HMRC, along with the employee’s income tax and NIC contributions, via PAYE. These are known as employers NICs.
For contractors on an agency payroll or fixed-term employment contract, this makes no direct difference to their net pay. Of course their gross salary will probably be lower, as their client employer would have factored the cost of employment into its budgets when creating the contractor’s position.
However, for umbrella company contractors, and limited company contractors who are paying a salary, perhaps because their contracts are inside IR35, national insurance must be calculated and paid out of their gross fees, in addition to any income tax and employees NICs due.
For regular employees, the employers NIC rate is 13.8%, which is charged on all earnings above £5,668. By way of an example, the employers NICs for the contractor earning £60,000 via PAYE in the example above would be £7,217.
A new scheme is due to start from April 2014, which will provide a £2,000 allowance to offset any employers NICs. Limited company contractors will immediately benefit. However, umbrella companies and agencies are unlikely to choose to allocate the allowance to their contractor employees.
Dividends and NICs
Dividends do not attract either employee or employer NICs and do not need to be taken into account when calculating contractors’ deductions. That is why, for limited company contractors, the low salary-high dividend model is so attractive.
Real Time Information (RTI) and NIC calculations
HMRC introduced its Real Time Information (RTI) initiative in April 2013, and by October 2014 all businesses will be required to submit payroll information in real time before or when any payments are made.
This means in practice, contractor employers will be using commercial software or HMRC’s free online tools to automatically calculate income tax and NIC contributions, and to submit the information online.