National Insurance: history and application
01 December 2019
This article was featured in the December 2019 - January 2020 issue of the magazine.
Lora Murphy ACIPP, CIPP senior policy liaison officer, reveals details of this employment and welfare keystone
A long with PAYE (pay as you earn) and pension deductions, National Insurance (NI) is another key deduction element that the majority of workers are accustomed to seeing on their payslips on a regular basis. Although we may moan and grumble about the detriment to the net pay that we eventually receive, it is important to remember that NI was implemented as a form of protection against times of hardship, and still acts in that fashion, even over a century after its initial introduction. It affects most of us at some point or, indeed, throughout our working lives but also extends into our retirement as the state pension is predominantly funded by ‘live’ NI contributions (NICs).
Given its prevalence within modern society, it seemed appropriate to study its origins and history, to explore the various classes of NICs and, most interestingly, to investigate how the NI fund is spent, and which classes contribute to which benefits.
A brief history
The National Insurance Act 1911 formed the basis of NI as we know it today, albeit on a considerably different basis. The fundamentals, however, remain unchanged, as both employees and employers have always had to pay NICs and the NI Fund always granted employees entitlement to certain benefits. Currently, employee and employer contributions are submitted electronically through the employer’s real time submissions to HM Revenue & Customs (HMRC), with payment of the due amounts made later by the employer. Historically, however, employers were expected to buy the relevant stamps at the post office and attach them to contribution cards on behalf of their employees. It was an entirely manual process as opposed to the technological treatment of NICs that we observe within payroll departments today.
There were two individual schemes at that point in time, one dealing with health and pension benefits and the other associated with unemployment benefit. The former was run by trusted societies and unions whilst the latter was a scheme controlled solely by the government. This soon changed with the arrival of the ‘welfare state’ in 1948, which heralded the homogenisation of the separate stamps resulting in one singular stamp to cover all benefits.
Things did not remain that simple, as they never do in the payroll sphere, and in 1975 the stamps became redundant as contributions were no longer paid at a blanket flat rate that was applicable to all. Instead, NICs were calculated based on the level of earnings an individual received and were collected via PAYE, at the same time as income tax. The NICs of this era were much more in line with how we treat and process it today, in stark contrast with how it initially originated all those years ago.
...state pension is predominantly funded by ‘live’ NI contributions...
Categories and classes
We are currently immersed in a society where there are not only a multitude of different NI classes to observe, but also a plethora of varying categories because somebody, somewhere obviously thought that payrollers’ lives were just far too easy. It is important to recognise the monumental differences between a NI category and a NI class as they dictate completely different things, and it is also imperative to remember that NI categories only apply to class 1 NICs.
The categories are associated primarily with age but there are also exceptions for apprentices, those who are already paying NICs in a separate job and for married women and widows who have an entitlement to pay lower NICs rates. Each category dictates both employee and employer percentage rates for individuals placed within scope. The standard NI category, applied to most employees, is ‘A’. The NICs categories as they currently stand can be found in Table 1. (The range of NICs categories can be viewed here: http://bit.ly/2CqjwiS.)
NI classes are a different beast altogether and are concerned with the employment status of an individual, their earning levels and their continuous NI record.
Payrollers would probably be most familiar with class 1 NICs which are those deducted via PAYE for earnings that exceed the lower earnings limit within a pay period. If you are classified as employed, these are the deductions that you will observe on your payslip.
Class 2 and class 4 NICs correlate with the self-employed: class 2 is based on individual earnings and class 4 is profits related. To ensure consistency both have thresholds attached to them, below which no NICs are due. Class 2 and class NICs are usually paid via self-assessment which the self-employed individual is responsible for.
Classes 1A and 1B are associated with employee benefits (P11D returns) and are paid across by employers.
Class 3 NICs are voluntary contributions that a person may make to complete their NI record to ensure that they are eligible for certain benefits.
How NICs are spent is wholly dependent on the class that they have been sourced from. Table 2 highlights the differences across the board. (Further information can be found here: http://bit.ly/2PYkURS.)
Figures from the most recent National Insurance Fund Account report reveal how much was collected by class in the year ending March 2018.
It is important to note that the figures in Table 3 have been collated independently of the National Health Service (NHS) allocation and shows the figures once the deduction has already been made.
...monumental differences between a NI category and a NI class as they dictate completely different things...
The application of NICs
Since inception, the NI Fund has operated on a pay-as-you-go basis. Thus, NICs received during a fiscal year pay for certain state benefits arising in-year.
A pre-determined portion of NICs is paid across to the NHS and the remaining monies are intended to be utilised exclusively for the pensions and benefits listed in Table 2. However, if there is a surplus in the NI Fund, the government may borrow money intermittently to assist with various projects.
The fund can also be accessed in order to invest into the Debt Management Account. This will come as a shock to some, as there is a common misconception that NI is used to pay for police officers’ salaries or for hospital appointments and for all other expenditures of that nature but there are other government schemes in place that allocate funds for this. But, even now, consistent with what it was first introduced for at conception, NI is largely used for pension and benefit payments.
The National Insurance Fund (NIF) is where all NICs related payments are held. The concept is that this fund holds ample capital to cope with the natural fluctuations to contributions and deductions that occur over time. It is particularly important that the fund holds sufficient funds to handle any periods in which significant pay outs must be made; for example, in the case of periods of high unemployment rates, where employment and support allowance figures will escalate. However, where payment figures exceed deductions, the additional funds get transferred to the National Insurance Fund Investment Account (NIFIA) and, conversely, when deductions exceed payments, the NIF takes from the Investment Account. The NIFIA is in existence to assist in the event of a deficit in the NIF.
The simple reality of the situation in relation to NI is that we can never predict with 100% certainty how much will be generated annually and we can never guarantee what the bill for pensions and various benefit payments will be. So, this is a two-pronged issue for predictions and estimations surrounding the likely status of the NIF and its figures.
Commentary
Although only a brief overview of NI, this article demonstrates how payroll contributes to the essential funding of a wide array of government policies. It also highlights how NI acts as a form of insurance for contributors and, indeed, wider society, as it’s effectively a saving towards state pension and also to benefits that, realistically, any individual could find themselves needing access to at some point in their lives.
It is impressive that what NI was originally set up to do has been maintained, although somewhat amended, and that the changing landscapes of society have not altered the foundations of NI completely. With the constantly evolving face of politics and perpetual changes to day to day life, it will be interesting to see the direction that NI takes in the future, so how it will change and adapt to slot in with new policies and technological advancements that are most definitely arriving over the next years and decades to come.