National Insurance Contributions (NICs)

The amount of State pension that an individual will receive upon reaching the State pension age (SPA) depends largely on their National Insurance Contributions (NICs) record during their working lifetime.

An individual will pay one or more of four different classes of NICs during their working lifetime, depending upon their status of employment:

Class 1 NICs – only for individuals in employment
Class 2 and 4 NICs – only for individuals who are self-employed
Class 3 NICs – voluntary contributions
NIC Credits

Class 1 NICs

Class 1 NICs only apply to individuals in employment. Class 1 NICs are paid by both the employee and the employer. Payment of Class 1 NICs allows an individual to build up an entitlement to the basic State pension and also, if they are not contracted out, the State Second Pension (S2P) (and previously the State Earnings Related Pension Scheme (SERPS)).

Employees’ Class 1 NICs are called primary Class 1 NICs
Employers’ Class 1 NICs are called secondary Class 1 NICs

Primary Class 1 NICs are paid by the employee on earnings between the primary earnings threshold and the upper earnings limit:

The primary earnings threshold is £110 per week (£5,715) for the current tax year (2010/11).
The upper earnings limit is £844 per week (£43,875) for the current tax year (2010/11).

Secondary Class 1 NICs are paid by the employer on all earnings above the secondary earnings threshold, which is set at £110 per week (£5,715) for the current tax year (2010/11).

If the employee is contracted into the S2P, Class 1 NICs are paid at the following rates:

The employee will pay primary Class 1 NICs of 11%.
1% on any earnings above the upper earnings limit.
The employer will pay secondary Class 1 NICs of 12.8%.

The lower earnings limit (LEL) is £97 per week (£5,044 per annum) for the current tax year (2010/11). The LEL does not have any effect on the level of NICs that are actually paid. However, it acts as a ‘zero band’ for those earning between £97 and £110 per week, which allows individuals in this category to build up an entitlement to the basic state pension.

Class 2 and Class 4 NICs

Class 2 and Class 4 NICs only apply to the self-employed. Payment of Class 2 and Class 4 NICs allows a self-employed individual to build up an entitlement to the basic State pension. The self-employed are not entitled to any of the earnings related State pensions. Their contributions are lower because of this.

Class 2 NICs are paid at a flat rate of £2.40 per week for the current tax year (2010/11).

A self-employed individual can choose not to pay Class 2 NICs if their profits are less than £5,075 in the current tax year (2010/11).

Class 4 NICs are based on a self-employed individual’s profits and are paid at the following rates:

8% on profits between £5,715 and the upper earnings limit.
1% on profits above the upper earnings limit.

Class 3 NICs

Class 3 NICs are voluntary and can be paid by those with an inadequate NIC record, by purchasing a special stamp or by direct debit.

Class 3 NICs enable individuals to increase their entitlement to the basic State pension. They are available to employees, the self-employed and those who do not work. The facility is not available to the following:

Individuals who will reach SPA in the current tax year and those older than SPA.
Married women or widows who have elected not to pay contributions.
Individuals not resident in Great Britain, although they may be able to pay if they wish to (see National Insurance leaflet NI 38).
Individuals who have already paid the required contribution for the tax year for it to qualify for the benefit.

For Class 3 NICs:

The weekly rate is £12.05 for the current tax year (2010/11).
If an individual wishes to pay Class 3 NICs, they must normally be paid within six years of the tax year in which the contribution shortfall occurred and before State pension age. However, an individual may have to pay more if it is paid after two years.

NIC credits

At times when an individual is unable to pay NICs, their entitlement to the basic State pension will be affected. In certain circumstances, NICs can be credited to enable such individuals to build up an entitlement to the basic State pension. For instance:

When claiming unemployment, maternity and sickness benefits.
By an unemployed man for the tax year in which he turns 60 and for the next four years.
By a person born since April 1957, who was at school or on an approved training course between the ages of 16 and 18 (years spent at university do not count for credit).
By someone taking time off work to raise a family or to look after an elderly or sick relative.

The final point is known as home responsibilities protection. Credit is not given for this for periods before 6 April 1978.

For more information, please contact us.