National Insurance

National Insurance (NI) in the United Kingdom was initially a contributory system of insurance against illness and unemployment, and later also provided retirement pensions and other benefits.It was first introduced by the National Insurance Act 1911, expanded by the Labour government in 1948 and has been subject to numerous amendments in subsequent years.
The contributions component of the system currently consists of mandatory contributions, National Insurance Contributions (NICs), paid by employees and employers on earnings, and by employers on certain benefits-in-kind provided to employees. The self-employed contribute partly by a fixed, weekly or monthly payment, and partly on a percentage of net profits above a certain threshold. Individuals may also make voluntary contributions, in order to fill a gap in their contributions record and thus protect their entitlement to benefits. Contributions are collected by HM Revenue and Customs (HMRC) through the PAYE system, along with Income Tax and repayments of Student Loans.
The benefit component comprises a number of contributory benefits of availability and amount determined by the claimant's contribution record and circumstances. Weekly income benefits and some lump-sum benefits to participants upon death, retirement, unemployment, maternity and disability are provided.
Recent developments of the system have meant that National Insurance provides a significant part of the government's revenue (£96.5 billion in 2010-2011, 21.5% of the total collected by HMRC.) National Insurance has also become more redistributive over time 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.

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 they are usually referred to simply as employee and employer contributions.
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 and remits the total to HMRC along with income tax.
There are a number of milestone figures which determine the rate of NICs to be paid: Lower Earnings Limit (LEL), Primary Threshold (PT), Secondary Threshold (ST), Upper Accrual Point (UAP) and Upper Earnings Limit (UEL). In this context "earnings" refers to an employee's wage or salary. The cash value of most of these figures normally changes each year, either in line with inflation or by some other amount decided by the Chancellor. The exception to this is the UAP, whose limit is fixed and not subject to routine uprating.

• On earnings below the LEL, no NICs are paid because no benefits can accrue on earnings below this limit.
• On earnings above the LEL, up to and including the PT, employee contributions are not paid but are credited by the government as if they were (enabling certain low-paid workers to qualify for benefits). Additionally, where the employee and/or employer contribute to certain types of occupational pension scheme, there is a negative contribution rate on earnings in this band - this 'rebate' can be offset against contributions in other earnings bands.
• On earnings above the LEL, up to and including the ST, employer contributions are not paid. As with the previous band, a 'rebate' may result from contributions to certain occupational pension schemes.
• On earnings above the PT (employees) / ST (employers), up to and including the UAP, 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/or employer make contributions
  • Whether the employee has reached the age at which State Pension becomes payable
  • Whether the employee is a married woman paying reduced-rate contributions. This facility was abolished on 11 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 and in employment
  • Whether the employee is an ocean-going mariner or deep-sea fisherman
• On earnings above the UAP, up to and including 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.
• On earnings above the UEL, yet another set of rates apply, this time depending only on whether the employee has reached the age at which State Pension becomes payable or is an ocean-going mariner or deep-sea fisherman

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 March 2011 Budget, the Chancellor announced that with effect from the 2012/13 tax year the PT will be indexed to inflation using the CPI, while other thresholds remain indexed using the RPI.

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/employee 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 and the tables are available only as downloads from the HMRC website. In addition, HMRC provide an online National Insurance Calculator.
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 (tax year 2011-12) of 13.8% of the value of the benefits in kind (from their P11Ds). Class 1A contributions do not provide any benefit entitlement for individuals.

Class 1B

Class 1B were introduced on 6 April 1999 and are payable whenever an employer enters into a PAYE Settlement Agreement (PSA) for tax. Class 1B NICs are payable only by employers and payment does not provide any benefit entitlement for individuals. They are paid at the same rate as class 1A contributions.

Class 2

Class 2 contributions are fixed weekly amounts paid by the self-employed. They are due regardless of trading profits or losses, but those with low earnings can apply for exemption 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, but do count towards Employment and Support Allowance

Class 3

Class 3 contributions are voluntary NICs paid by people wishing to fill a gap in their contributions record which has arisen either by not working or by their earnings being too low. Class 3 contributions only count towards State Pension and Bereavement Benefit entitlement. The main reason for paying Class 3 NICs is to ensure that a person's contribution record is preserved to provide entitlement to these benefits, though care needs to be taken not to pay unnecessarily as it is not necessary to have contributions in every year of a working life in order to qualify.

Class 4

Class 4 contributions are paid by self-employed people as a portion of their profits. The amount due is calculated with income tax at the end of the year, based on figures supplied on the SA100 tax return.
Contributions are based around two thresholds, the Lower Profits Limit (LPL) and the Upper Profits Limit (UPL). These have the same cash values as the Primary Threshold and Upper Earnings Limit used in Class 1 calculations.

• No class 4 NICs are due on profits up to and including the LPL.
• Above the LPL, up to and including the UPL, class 4 NICs are paid at a rate of 9% (tax year 2011-12).
• Above the UPL, class 4 NICs are paid at a rate of 2%.

Class 4 contributions do not form part of a qualifying contribution record for any benefits, including the State Pension, as self-employed people qualify for these benefits by paying Class 2 contributions.

NIC credits

People who are unable to work for some reason may be able to claim NIC credits (technically credited earnings, since 1987). 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 past years in contribution records for some benefits.

National Insurance and PAYE Service

National Insurance contributions for all UK residents and some non-residents are recorded using the NPS computer system (National Insurance and PAYE Service). This came into use in June and July 2009 and brought NIC and Income Tax records together onto a single system for the first time.
The original National Insurance Recording System (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, introduced in 1996, was a large and complex computer system which comprised several applications. These included 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 was some controversy regarding the NIRS/2 system from its inception when problems with the new system attracted widespread media coverage. Due to these computer problems Deficiency Notices (telling individuals of a possible shortfall in their contributions), which had been sent out on an annual basis prior to 1996, stopped being issued. The (then) Inland Revenue took several years to clear the backlog.