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FOOL SCHOOL
National Insurance is a tax in all but name. Indeed, since April 1999 it has been a branch of the Inland Revenue, formerly a separate government department known as the Contributions Agency.
It is a heavy imposition, particularly on the employed sector. In many businesses, the Pay-As-You-Earn (PAYE) figure that has to be paid over monthly or quarterly to the Inland Revenue, representing the total tax and NI deducted from employees' salaries plus the employer's NI contributions, now consists more of NI than tax. Quite an amazing fact, really, considering how understated NI can be as far as publicity is concerned. That is how substantial a tax it has become.
The trend is for NI to be merged with the tax system. In fact there was, and still is, a crazy system of different rules applying to the levels at which tax and NI were applied to incomes requiring in effect two distinct sets of computations to be applied to the same income, in order to determine NI liability on the one hand and income tax on the other. Eventually there may be a unified system, but we are still a long way from that.
Broadly speaking, the principal difference between income tax and NI is that the former applies to income of all types, but the latter applies only to what might loosely be termed earned income. This is income from employment and self-employment. Specifically, investment income from things like interest, dividends or rent is excluded from NI, although liable in general to income tax.
Let's look at the types of NI contribution. They are known as "classes" and there are four, although the first is subdivided into some lesser types.
Class 1
This is probably the most common, being the NI contributions payable by employed people. It consists of two parts, known officially as the primary contribution and the secondary contribution. The primary contribution is payable by the employee, the bit you see deducted from your wages if you are employed. The secondary contribution is payable by the employer.
For 2004/05 the primary contribution starts on an income of £91 per week and goes up to £610 per week with a rate of 11% being charged on anything between £91 and £610. Any earnings above £610 are charged at 1%. So, for example, someone earning £100 per week pays 90p (11% of £100-£91). Someone earning £800 per week pays £58.99 (11% of £610-£91 plus 1% of £800-£610).
For this year, the secondary contribution is 12.8% on incomes over £91 per week, without upper limit. So on the same income of £100 per week, the employer is liable for £1.15 (12.8% of £100-£89. In the £800 per week example, the employer is liable for £90.75 (12.8% of £800-£91).
Class 1 applies only to those aged over 16. Below that there are neither primary nor secondary contributions required. At the other end of the age scale, primary contributions are not required by those over the state pensionable age, currently 60 for women and 65 for men. Note though that secondary (i.e. employer) contributions still have to be made in respect of employees over these ages.
Class 1A This is a special employer-only rate of 12.8%, payable on benefits provided to employees. Class 1B This again is an employer-only rate payable on PAYE settlement agreements. It's an obscure point that arises where an employer provides a modest taxable benefit to a large group of employees. Class 2
This is a compulsory self-employed contribution. A flat rate weekly sum of £2.05 for 2004/05. A self-employed person is not liable where the profits are less than £4,215 for 2004/05, and nor are those under 16 or over 60 for women, 65 for men. The usual method of payment is by direct debit, although it can be paid by quarterly invoice.
Class 3
These are voluntary flat rate contributions which can be paid by those under the same ages as above, where the contribution record may otherwise be inadequate to claim a pension. Class 3 NI could be paid, for example, by those who are not working and not receiving social security benefits of some kind, by those abroad, by mature students and so on. The rate for 2004/05 £7.15 per week.
Class 4
NI for the self-employed again. These are compulsory percentage-based contributions payable on annual profits. The rates are 8% on £4,745 and £31,720 per year and 1% above £31,720 per year. Again, the upper age limits above apply; contributions are not required from men over 65 or from women over 60.
And that's it for the classes of contributions required for NI. Note that the self-employed are required to pay both classes 2 and 4.
What do you get for your money?
Unlike income tax, NI is the basis for a range of state benefits, the retirement pension probably being the most common. Those benefits are in many cases based upon the contribution record of the individual, and are not the same for everyone.
The self-employed get a poorer deal, but then they often pay less than an employed person on a similar income. For example, they are not entitled to Jobseekers' Allowance or the Second State Pension.