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National Insurance (NI) is often the “hidden tax” that many people do not fully understand – or factor into their tax-mitigation plan. Yet it can make a big difference to your take-home pay (and your profit margins, if you are a business owner). With NI in the news lately, due to the UK Government recently pledging to increase it by 1.25% by the 6th April 2022, we wanted to offer this update to readers about how NI works, how it affects your financial plan and how you can steps to mitigate needless taxes from eroding your spending and saving power.
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What is National Insurance?
National Insurance (NI) was introduced in 1911 and expanded after the Second World War in 1948. It was initially designed as a levy to help people through illness and unemployment. Over the years, however, it has become a crucial source of funding for pensions and state benefits.
Lately in 2021, moreover, the UK government has stated that NI will play a more important role in helping to fund social care. From October 2023, the plan is that no one should pay more than £86,000 over their lifetime on home/residential care.
Both employees (those under state pension age) and employers pay NI. The amount you pay depends on what you earn and your employment status (which determines your NI “class”). For instance, employees pay Class 1 NI contributions and employers pay Class 1A/1B. If you are self-employed, then Class 2 or 4 contributions apply.
Income tax & NI
Many question why the UK has both an Income Tax and a National Insurance tax. Yet there are some important distinctions between the two. Firstly, Income Tax is calculated on a cumulative basis. NI, however, is calculated on a “per payment” basis. If your salary is near to the low/high NI threshold, then this can distort the overall tax you pay.
Secondly, Income Tax is calculated on an individual’s total salary during the financial year. NI, conversely, is calculated on each source of income. If you earn £10,400 from one employment, for instance, then you will likely pay NI on £2,260. However, if instead you earn £5,200 from two separate jobs during a given financial year, then no NI will be calculated on these earnings.
Can I reduce my NI contributions?
Here, it is crucial to recognise that we all have a duty to pay our taxes and contribute to society. With that said, nobody should pay more tax than necessary – especially when that money could otherwise go towards your family and future.
For employees – particularly higher earners – it is important to consider the role of your pension within your wider tax mitigation strategy. Bear in mind that, whilst income tax relief is available on your own pension contributions, these do not also receive NI relief. In fact, when you make pension contributions, these are subject to NI for both you and your employer.
However, employer contributions to your pension are not subject to NI. Therefore, by structuring things correctly, it may be possible to reduce your NI by lowering your pension contributions and your employer raises them. This could also reduce your employer’s tax bill, in the process!
If you are self-employed, then in some cases it might make sense to set up a limited company. This can open up some tax-saving options for you. Remember, self-employed people pay Class 2 and Class 4 NICs, which are paid via Self-Assessment. The Class 4 rate is 9% on yearly profits of between £9,568 and £50,270 per year, and 2% on amounts above £50,270. Setting up as a limited company lets you avoid the Class 4 contributions, which could lead to a tax saving.
Moreover, company directors are deemed to be “employees” by HMRC. They pay NI on yearly income from salary and bonuses over £9,568. Therefore, if you own/control all the shares in the company then drawing money in the form of dividends could result in a tax saving.
One final avenue to consider revolves around child vouchers. These vouchers, up to £55 per week (or £243 a month), are exempt from NICs for both employers and employees. By offering them to your staff, you could lower some of your business costs and your staff could also save on their childcare costs. These could even be done under a salary sacrifice arrangement. Other benefits can also be offered to staff, tax-free, including mobile phones, applicable mileage rate and even vans. (Company cars, fuel and medical reimbursements may be subject to tax).
As you can see, there are a lot of intricacies to national insurance. It can help to gain the advice of a professional financial adviser to make sure you place yourself in the best tax position.
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or firstname.lastname@example.org