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How Is National Insurance Calculated And How Does It Affect Your State Pension?

How is national insurance calculated

National Insurance contributions play an important role in funding the state pension and the number of payments you’ve made directly impact the amount of money you will be entitled to receive in retirement. It’s therefore important to understand how NI works, to keep track of your contributions and ensure that you’ve paid enough to be eligible for the State Pension in your later life.

National Insurance Factors to be aware of: 

  • Earnings threshold: there are different thresholds for employed and self employed people
  • Classifications: Class 1 for employees, Class 2 for self-employed with profits over a certain level and Class 3 for voluntary payments.
  • Rates: Vary depending on employment status and earnings.

National Insurance is a mandatory tax paid by workers and employers in the UK on earnings made through work. Amounts paid will depend on employment status, income level and how old someone is because there are different classes of National Insurance (NI) contributions based on these factors.

Funds collection through this tax are used to support the welfare system in the UK, including the payment of the state pension. Healthcare, maternity benefits and unemployment support is also generated from this tax.

Read on to understand these points in more detail.

What Is National Insurance?

National Insurance is a compulsory tax in the UK and is payable by:

  • workers (16 years old and over)
  • Self employed people
  • Employers

It’s the government’s system of social security that is collected to help pay for state benefits and is collected by HMRC. Once you reach state pension age, you stop paying the tax.

There are 3 classes of NI to be aware of:

  • Class 1 – paid by employees earning above a certain threshold, which is set by the budget each year.
  • Class 2 – pad by self employed people with profits over a certain level
  • Class 3 – Voluntary contributions

The amount you pay is determined by your earnings and employment status and you will need to meet a qualifying number of years of paying NI to be able to receive the full State Pension. You can check your current status of your National Insurance record at any time here: https://www.gov.uk/check-national-insurance-record

How Is The Amount Of NI Owed Calculated?

NI gets most of its revenue from employees. A fee which is deducted from their wages before tax. Obviously employers also have to pay their NI. The self-employed are not spared either but they must pay their tax via a self assessment tax return each year.

For example:

  • Self employed have to pay higher NI than workers.
  • You do not have to pay NI if you are employed but earn less than £242 per week.
  • Self employed earning over £6, 725 per year will pay a higher NI rate.
  • Amount of NI owed increases as a person’s earning raises.

Calculating National Insurance Payments

NI is calculated as a % of what you earn, thus, how much you will pay, will depend on your earning and your employment status. Some people will need to pay more than one classification of NI. Those who are employed and self employed for example.

Suppose you’re employed. The NI will be cut from your wages. Income tax and pension contributions will also be deducted before you receive your wages. This system is called PAYE. (Pay As You Earn).

On the other hand, if you’re self-employed it is your own responsibility to pay for the NI. You can know how much you need to pay through self assessment at the end of each tax year.

  • Class 1: Employers will deduct the NI fee from the salary of their employees. But they will do so only for those receiving £242 or more per week. This is known as the LEL (Lower Earnings Limit). For their part, self-employed people are also eligible to class 1 NI. The requirement is that they earn above the Small Profits Thresholds (SPT) which is set at £6,725.
  • Class 2: This is for the self-employed. A flat rate annual payment of £3.50 per week. It is for the self employed people who have an annual profit above the SPT. They can pay their NI via Self Assessment.
  • Class 3: This is a voluntary payment that you can make to top up your NI record in order to qualify for the state pension ( if, for some reasons, you have gaps in your NI records, this is the route most people take), by gaps we mean, for example, suppose you did not work for a year to take care of someone.
  • Class 4: This is for self-employed people who earn over the Upper Profits Limit (UPL). The UPL is £50,270 for 2021/22. (10.25 % of profits over this amount).

Current Tax Year NI Payments

Who sets the NI amount owed for each class every tax year? The Chancellor in the annual budget.

For the 2021/22 tax year, the rates were as follows:

  • Class 1: 13.25% on earnings between £242 and £967 a week. In other words, £1,048 to £4,189 a month! And, 3.25% on any amount over £967 a week, in other words, £4,189 a month!
  • Class 2: £3.50 per week
  • Class 3: These are voluntary contributions. you can pay them to fill or avoid gaps in your National Insurance record.
  • Class 4: 10.25% on profits between £11,909 and £50,270. And, 3.25% on profits over £50,270!

You’ll stop paying national insurance contributions once you reach state pension age. To work out your state pension age, use this handy guide from HMRC.

Still confused? You can always seek help from the HMRC National Insurance helpline. They will help you to calculate your NI.

If you’re employed and self-employed

What do you need to do if you’re both employed and self-employed? In this particular scenario, you will be affected by class 1 NI. Your employee will deduct your contribution from your salary but you may also have to pay Class 2 or Class 4 NI which is for self-employed earnings.

Which of these two classes you have to pay will depend on how much money you are earning. Fill in your Self Assessment tax return for the year and you will be notified how much you will need to pay. If you use digital accounting services, this will also help you to keep the amount owed front and centre.

Where Can I Find My National Insurance Number?

Your National Insurance number is unique to you and is used to make sure your NI contributions and tax are calculated correctly. You’ll need to quote it whenever you fill in a form related to employment or pensions, for example when you start a new job or when you apply for a state pension.

Everyone has a unique National Insurance number. It is used to check if the NI contributions as well as tax are calculated correctly. You will use it in employment forms and pension forms and when talking to HMRC. If you can’t remember your number, you will find it on the following documents:

  • On your payslip
  • On your end-of year summary of pay and tax (P60)
  • Check your National Insurance card, if you still have it. It is there too!
  • On any letter from HMRC or the Department for Work and Pensions about your NI contributions or state pension.

If you still cannot find your number, you can ask help from the NI helpline.

What Are The Benefits Of Paying National Insurance?

Are there really some benefits of paying the National Insurance? Yes, there are! It supports those who cannot work because of illness and those who cannot find a job. It also helps families and retirees who have lost someone on whom they relied on financially. In addition, NI benefits the National Health services as well as other public services. Any one of us could need to call upon these services in our lifetime and for most, we will rely on the State Pension to help us through our retirement years.

This contribution ensures that the box of public services has enough funds. Plus, it also benefits you as it provides financial protection for you and your family.

How Are My NI Contributions Spent?

Every year, the UK government collects billions of pounds through the NI contributions. In 2019/20 for example, the contribution amounted to around £162 billion. This money is extremely important as millions of people in the UK rely on it.

It is distributed among state pensions and other benefits. Winter Fuel Payments and free TV licences for older people are funded by this money. Maternity and sick pay as well as unemployment benefits also come from this fund. The NI contributions help to pay for other public services and NHS as well.

How Does National Insurance Affect My State Pension?

To this date, the full state pension is £185.15 per week. To be eligible for this amount, you have to have paid 35 years National Insurance contributions. If you accrue less than this, you will only be eligible for a partial state pension and if you have less than 10 years contributions, you won’t be eligible at all.

If you belong to the workforce or are self-employed, you will begin contributing to your state pension via NI payments in April of the year following your 16th birthday.

Who Can Help Me With National Insurance Questions?.

Still confused? If you have any questions about the NI, check the official GOV.UK website. You will find a lot of information there. You can also receive guidance and help by contacting the NI helpline at  0300 200 3500 or HMRC’s Self-Assessment helpline at 0300 200 3310.

What Is A National Insurance Number?

We all have a unique NI reference number and it will be issued to you by the Government once you are 16 years old.

The format of an NI number is usually two letters followed by six numbers then a single final letter. Two first two letters are random, and the final letter is a check digit used for verification purposes. The middle 6 numbers, whilst unique, do not have any specific meaning.

Each person will keep their own NI number for life and will be asked for it when talking to HMRC, starting a new job, moving house, and any situation where you need to prove your identity.

What If I’ve Paid Too Much NI?

Afraid that you’ve paid too much NI? It can happen. Don’t worry, the HMRC will refund you. All you have to do is fill out a form and show your proof of earnings and contributions. The form is called a refund form. But, be careful, there is a time limit for requesting a refund. So be sure to stay on top of your contributions and act quickly if you spot an overpayment.

Where Can I Check My National Insurance Contributions?

It is important to check your NI record. From this, you can make sure of two things: that you are contributing the right amount, and that you are not overpaying. By checking this, you also make sure that you will receive the right state pension after retiring. From where to check it? From online, via post or by phone.

You can check your balance online. Log in to your Government Gateway account (Tax account). If you don’t have it yet you can create one. Go to the GOV.UK website to sign up. Once it is done, go to the menu. Select ‘National Insurance’. Next select ‘View my records’. You will see how much NI you have contributed.

You can check it by phone too. Simply call the Self-Assessment helpline. If you want, you can even check your balance by post. For that you need to request the HMRC for a statement.

You can use all these options to verify your contributions and if you spot something that you are unsure of, or any errors on your record, contact HMRC.

Summary

Paying National Insurance is a legal requirement for most working aged people in the UK and the funds collected go towards the social security system which acts as a safety net for those in need of health and welfare support during their lives and towards funding the State Pension when you reach retirement age.

The amount you earn and your employment status affects how much you will need to pay and HMRC can answer any questions that you may have.

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