What is National Insurance?

National Insurance is an essential part of the UK’s tax system, funding services like the NHS and the state pension. While it’s often compared to Income Tax, National Insurance has distinct rates, rules, and purposes. It’s important for UK taxpayers to understand how it works, as it affects both your take-home pay and your entitlement to benefits like the state pension.

A Brief History of National Insurance

National Insurance was introduced in 1911 by the Liberal government as a way to provide financial security for workers, covering healthcare and unemployment benefits. Over the decades, the system has evolved to fund a wider range of social benefits, including state pensions and statutory maternity pay. Today, it is a cornerstone of the UK’s welfare system, ensuring that both employed and self-employed individuals contribute towards essential public services.

Why National Insurance is Separate from Income Tax

Although both National Insurance and Income Tax are deducted from your salary, they serve different purposes and operate under separate systems. National Insurance contributions (NICs) fund specific social welfare programmes like the state pension, maternity leave, and sickness benefits. In contrast, Income Tax goes into the government’s general revenue, funding a wide range of public services, from education to defence.

Another key difference lies in how they are applied. While Income Tax is calculated based on your total income, National Insurance is mainly charged on earnings from employment and self-employment. This means that dividends, rental income, and interest from savings, for example, aren’t subject to National Insurance.

Additionally, NICs are linked to specific thresholds and rates, which are applied to your earnings in each pay period. Income Tax, by contrast, is applied cumulatively across the tax year. This means that with National Insurance, your contribution may fluctuate from month to month depending on how much you earn during that period.

How National Insurance Works for Employees

If you’re employed and earn above a certain amount, you’ll need to pay National Insurance. Fortunately, your employer takes care of the deductions automatically, making the process seamless for most workers.

For the 2024/25 tax year, employees pay National Insurance once their earnings exceed £12,570 a year:

• Earnings between £12,570 and £50,270: You’ll pay 12% on the portion of your earnings within this range.
• Earnings above £50,270: You’ll pay a reduced rate of 2% on any amount over this threshold.

Let’s break this down with an example: if you earn £40,000 a year, you’ll pay 12% on the portion of your income that exceeds £12,570 but stays below £50,270. If your income rises above £50,270, the 2% rate kicks in for that extra amount. Keep in mind, these rates apply to each pay period, so your contributions could vary depending on how much you earn in a particular month.

How National Insurance Works for Employers

Employers also have an obligation to contribute to National Insurance on behalf of their employees. These employer contributions are an added cost on top of the wages they pay you and are not deducted from your salary.

For the 2024/25 tax year, employers pay 13.8% on employee earnings above £9,100 a year. Unlike employee contributions, this rate doesn’t reduce after a certain threshold—it remains fixed at 13.8%. Employers are responsible for calculating and paying these contributions to HMRC, ensuring that they’re submitted in line with the payroll schedule.

While the process is generally handled by the employer, it’s useful for employees to be aware that their total cost to a business includes both their salary and the employer's National Insurance contributions.

National Insurance for the Self-Employed

If you’re self-employed, National Insurance works a little differently. You’re responsible for paying two types of contributions: Class 2 and Class 4.

• Class 2 contributions: A flat rate of £3.45 per week, paid if your profits are above £12,570 a year.
• Class 4 contributions: These are paid on your profits. For the 2024/25 tax year, the rate is 9% on profits between £12,570 and £50,270, and 2% on profits above £50,270.

Both Class 2 and Class 4 contributions are paid via your Self-Assessment tax return, so it’s important to keep track of your profits and factor National Insurance into your overall tax planning.

National Insurance Categories

To make things clearer, National Insurance is divided into different classes depending on your employment status:

• Class 1: Paid by employees and employers based on earnings.
• Class 2: A flat rate for self-employed individuals.
• Class 3: Voluntary contributions made to fill gaps in your National Insurance record, often to ensure eligibility for the full state pension.
• Class 4: Paid by self-employed individuals based on their profits.

Why National Insurance Matters

National Insurance contributions are more than just another deduction from your pay—they determine your entitlement to key benefits, such as the state pension. To qualify for the full state pension, you need at least 35 years of National Insurance contributions. If you have gaps in your record—perhaps from periods of unemployment or part-time work—you may receive a reduced pension.

Thankfully, it’s possible to fill these gaps by making voluntary contributions (Class 3 NICs). This is an important consideration if you want to ensure you receive the maximum benefits when you retire.

Beyond the pension, National Insurance provides access to other essential benefits such as:

• Statutory Sick Pay
• Maternity and Paternity Pay
• Bereavement Support Payment
• Unemployment benefits, like Jobseeker’s Allowance

Your Role in the National Insurance System

National Insurance is a fundamental part of the UK’s social security system, supporting vital public services and providing financial protection for individuals in times of need. While it shares some similarities with Income Tax, it’s a distinct system with its own rates, thresholds, and rules. Whether you’re employed, self-employed, or an employer, understanding how National Insurance works is key to managing your finances and ensuring you’re entitled to the benefits you deserve.