Self-employed NIC reform – a trap for the lowest paid
When the Chancellor of the Exchequer announced the reversal of his Budget measure to increase the rate of Class 4 National Insurance contributions (NICs), saying that there would be no rate increases during the current Parliament, the self-employed may have breathed a sigh of relief. But National Insurance is soon to become a great deal more expensive for some self-employed earners on very low profits. Those who are currently able to build up entitlement to the state retirement pension and certain other benefits by paying Class 2 contributions at a cost of £2.80 a week will face a fivefold increase from April 2018. [Note (17-10-18) – postponement of abolition of Class 2 to April 2019 in the 2017 autumn Budget statement – see 'Budget November 2017 – Change, Challenges and Opportunities']
NICs payable by the self-employed are one of the least understood areas of the tax system. That is hardly surprising, given that the self-employed must pay not one, but two, types of National Insurance, known as Class 2 and Class 4, subject to different rates, rules and structures. Class 4 is not dissimilar to the Class 1 contributions payable by employed workers and their employers: starting at profits of £8,060 (in 2016/17), Class 4 is chargeable at 9% until profits reach £43,000, then at 2% above that.
Class 2, by contrast, is a flat-rate £2.80 a week. Like Class 4, it is normally payable with the self-assessment tax bill by 31 January following the tax year-end. But unlike Class 4, payment of Class 2 establishes the payer’s right to access contributory benefits such as the state retirement pension, bereavement benefits, maternity allowance, and contributory employment and support allowance (ESA).
Changes in prospect
From April 2018, the Government proposes to bring NICs paid by the self-employed into line with those paid by employees by abolishing Class 2 altogether and remodelling Class 4. A policy document issued at the time of the 2016 Autumn Statement contains the following explanation:
“After abolition [of Class 2], those with profits between the Small Profits Limit and the Lower Profits Limit will not be liable to pay Class 4 contributions but will be treated as if they have paid Class 4 contributions for the purposes of gaining access to contributory benefits. All those with profits at or above the Class 4 Small Profits Limit will gain access to the new State Pension, contributory Employment and Support Allowance (ESA) and Bereavement Benefit. Those with profits above the Lower Profits Limit will continue to pay Class 4 contributions.”
The small profits limit and the lower profits limit are likely to equate with the Class 1 lower earnings limit and primary threshold respectively, so that those with profits between (using current figures) £5,824 and £8,060 p/a will be credited with NICs, while those with profits above £8,060 will have to pay 9% of their earnings above that limit. Class 4 will then give access to the same contributory benefits as are currently secured by paying Class 2.
But the abolition of Class 2 will have adverse consequences for those with profits below the current small profits threshold (£5,965 p/a) who are not obliged to pay Class 2 but are doing so voluntarily in order to build up their contributions record. If they wish to continue to secure contributory benefits by paying NICs after April 2018, they will instead have to pay voluntary Class 3 contributions, currently payable at the rate of £14.10 a week – a fivefold increase.
In addition, the special rates of NIC now payable by share fishermen (£3.45 a week) and volunteer development workers (£5.60 a week) will cease from April 2018. They too will have to pay Class 3 if they wish to continue building up their contributions record.
We are told that Class 3 will be expanded to give access to the standard rate of maternity allowance and contributory ESA as well as the state retirement pension. And low-paid self-employed, share fishermen and volunteer development workers will be able to ‘rely on their contributions record in the two years prior to Class 2 abolition for longer than usual when claiming contributory ESA and, where eligible, contribution-based Jobseeker’s Allowance. . . these arrangements will remain in place until 1 January 2022’.
What should people do?
The picture around self-employed NICs is further confused by the fact that in April 2015, Class 2 – which had been payable monthly or six-monthly by direct debit or payment of a twice-yearly bill – was incorporated into the self-assessment payment system. At the same time, the rule whereby low earners had to opt out of paying Class 2 by applying for a small earnings exception was removed in favour of an opting-in process, under which those with profits below the small profits limit had to apply to pay Class 2 if they wanted to protect their entitlement to benefits. We explain these changes in more detail elsewhere on this site.
In all likelihood, not everyone who had not opted out of paying Class 2 before April 2015 has appreciated that they now have to opt in. So the first thing to do, if you have profits below £5,965 a year, or are a share fisherman or volunteer development worker, is to check your Class 2 record for the last few years. You can do this online, by logging into your Personal Tax Account, or by telephone or post. GOV.UK explains how. If there are gaps, it is possible to fill them by applying to make backdated payments of Class 2. You can go back for six years.
It is possible that you may be able to claim National Insurance credits for a particular year, in which case there is no need for you to pay any contributions for that year.
If you think you might need to claim contributory ESA or contribution-based JSA in the next few years, make sure that you pay any necessary Class 2 contributions throughout 2016/17 and 2017/18 to take advantage of the extended entitlement referred to in the policy paper quoted above.
If your wish is to protect your state pension entitlement, ensure that you have paid and continue to pay as many Class 2 contributions as you need to before abolition. You need 35 years of contributions paid or credited to be entitled to the full state pension. The minimum needed to secure any state pension is 10 years. Some may be entitled to claim state pension credit which is currently equal to the full state pension, but as that is a means-tested benefit entitlement is by no means automatic.
The abolition of Class 2 is primarily a simplifying measure, and while we appreciate that NICs for the self-employed will become easier to understand, we shall continue to argue for the lowest paid self-employed earners to be able to save for their state pension at current rates.