National Insurance Contributions (Rate Ceilings) Bill

Explanatory Notes

Annex A - Overview of National Insurance

The National Insurance Scheme was first established in 1911 and expanded in the late 1940s to provide funds for a more comprehensive and inclusive range of contributory benefits and to provide assistance with the funding for a new National Health Service.

Receipts from contributions are paid into the National Insurance Fund ("NIF") which is separate from all other revenue raised by national taxes. The NIF is used exclusively to pay for contributory benefits and operates on a pay as you go basis: broadly speaking, this year’s contributions pay for this year’s benefits.

Briefly, the scheme consists of a number of benefits financed by NICs payable by earners, employers and others. Employees pay NICs on their earnings, employers pay NICs on the earnings they pay to their employees and the self-employed pay flat rate NICs and NICs on their profits and gains.

An earner can be either an employed earner or a self-employed earner. An employed earner is a person who is gainfully employed in Great Britain or Northern Ireland either under a contract of service, or in an office (including elective office) with earnings. A self-employed earner is a person who is gainfully employed in Great Britain or Northern Ireland otherwise than as an employed earner. Provision is made within the scheme to allow those who are not compulsorily covered to protect their entitlement to state retirement pension and bereavement benefits by means of voluntary NICs payments.

NICs are currently divided into seven classes:

Class 1 contributions, which are paid by both employees and employers on the employee’s earnings, are payable at 12% and 2% by employees and 13.8% by employers.

Class 1A contributions are payable annually, by employers and third parties, on most taxable benefits in kind. Class 1A contributions are payable at a rate of 13.8%.

Class 1B contributions are payable annually, by employers on items which are dealt with under a PAYE Settlement Agreement ("PSA") for income tax. Class 1B contributions are payable at a rate of 13.8% on the value of items included in the PSA and on the total tax payable by the employer under the PSA.

Class 2 contributions are paid by the self-employed at a flat rate of £2.80 per week for the 2015-16 tax year if their annual earnings from self-employment are at or above the Small Profits Threshold (currently £5,965). From April 2015 Class 2 contributions are collected through Self-Assessment for most self-employed individuals. An individual whose earnings from self-employment are below the Small Profits Threshold can pay Class 2 contributions voluntarily.

Class 3 contributions are payable at a flate weekly rate of £14.10 for the 2015-16 tax year by people who are not otherwise liable to pay Class 1/Class 2 contributions, to protect entitlement to State Pension.

Class 4 contributions are paid annually by the self-employed on profits chargeable to tax as trading income. Class 4 NICs are payable at a rate of 9% on profits between a lower and upper profits threshold and 2% on profits above the upper threshold.

Class 3A was introduced in the Pensions Act 2014. It will be payable on a voluntary basis for a limited period (12 October 2015 to 5 April 2017) by those who reach state pension age before 6 April 2016.

Prepared 14th July 2015