National Insurance – a contractor’s guide

National Insurance (NI) is often misunderstood, even by the most experienced of contractors so it’s important to start by dispelling some of the myths about NI – while explaining what it is; who pays it, why, and how not to – legally, writes Martin Mckechnie, a director at The Low Tax Group.

A tax in all but name?

NI may seem like a tax, but it differs from income tax in two main ways. Firstly, not everyone needs to pay it. It is only payable on earnings by those employed or self-employed above the age of 16 and below the statutory retirement age (which, from 2020, will be 66 for both men and women). The second main difference is that payment of NI gives rise to entitlement to certain state benefits, recorded through your National Insurance Number. All NI payers can build up an entitlement to State Pension and those who are employed can also build up a Jobseekers Allowance entitlement.

How much NI should you pay?

The amount you pay depends on whether you are self-employed or employed and how much you earn.

Put simply, the self-employed pay Class 2 NI at £2.50 per week and also Class 4 on their profits at 9%. The employed pay Class 1 (primary) at 12% of “taxable” income up to £42,750 after deducting various allowances.

Above £42,750 both Class 4 and Class 1 rates are reduced to 2% for income/profits above this amount. This 3% difference may not seem like a huge amount to pay in order to be entitled to Jobseekers Allowance, but if you are employed, then your employer also has to make an additional contribution of Class 1 (Secondary) at 13.8% on all of your taxable income.

National Insurance as a Limited Company

If you trade through a Limited Company then you will be treated as an employee for NI purposes. Self-employed NI is only for those who trade in their own personal name and have registered with HMRC as such.

You will notice that only employees and the self-employed pay NI. One of the advantages of owning your own Limited Company is that you can receive dividend income which, because it is treated as a return on your investment in the shares of the company, is not subject to NI.

As the company is free to pay its directors whatever they want (directors’ income is not subject to minimum wage legislation), it makes sense to maximise the amount paid by dividend and therefore avoid paying employees and employers NI.

How to get state support without paying NI

At this point, aspiring limited company contractors might understandably wonder about the benefits they would get if they did pay NI. If you don’t pay National Insurance, will you still get a state pension? Well, there is a specific wrinkle in the law that can be taken advantage of. NI is not payable until employed earnings exceed £139 per week (the primary threshold), but the NI system starts for income above £102 per week (lower earning limit). Should you be paid between these two amounts, then you are given a credit for NI, without having to pay a NI contribution as either an employee or employer. This free credit was setup to help the low-paid build benefits entitlements, but is available for contractors who have no problems sticking to the letter of the law, if not the spirit.

How to legally minimise your NI bill            

There are ways to avoid or minimise the NI liability. If you own or control all the shares in your company then dividends achieve this end. However for those contractors not in such a position, or for contractors who use an umbrella company, the dividend route is not open. You might also find that if you are part of an umbrella company your employer will look to reduce their costs by passing on their NI liability to you.

The most common non-dividend way to legally avoid NI is by way of “non-cash remuneration”. You could use a specially designed “tax scheme” that needs to be registered with HM Revenue & Customs, which may or may not work. Alternatively, you could maximise your expenses, which because they are not “earnings” are not subject to NI. I would urge caution here as some providers seem to suggest that they can allow special rules for expenses, but actually, every employer is subject to the same HMRC rules on expenses.

Martin Mckechnie is Client Services Director at The Low Tax Group, a firm of accountants and tax advisory specialists.