What it means
Contributions are grouped into classes. Class 1 covers employees and their employers, Class 2 and Class 4 cover the self-employed, and Class 3 is a voluntary class people use to fill gaps in their record.
Because contributions build entitlement as well as raising revenue, missing years can reduce a person's future state pension. The employee side is deducted at source through payroll along with income tax, so most people only see the net figure on their payslip.
Employees pay nothing below a lower earnings threshold, a main rate on earnings between that threshold and an upper limit, and a much lower rate on everything above it. That upper limit is what makes the overall burden lighter on higher salaries as a percentage of pay.
The employer side is the part that catches businesses out. Employer contributions are charged on earnings above a separate, lower threshold, with no upper limit at all, so the cost keeps rising with salary.
Whenever a hiring manager quotes a salary, the true cost to the business is that salary plus employer contributions plus pension, which is a materially bigger number. The self-employed pay under a different set of rules that historically produced a lower total charge than an employee and employer pay combined on the same income.
That gap is a large part of why employment status disputes matter so much to tax authorities and why the off-payroll working rules exist. One practical point: rates and thresholds are reset each tax year in the Budget, sometimes significantly, so any figure quoted in a glossary is a snapshot rather than a permanent rule.
The structure, meaning thresholds, a main rate and a reduced rate above an upper limit, changes far more slowly than the numbers themselves.
In practice
Real-world examples.
Example
A marketing agency budgets for four new hires at GBP 45,000 each and forgets employer contributions entirely. Adding 15% on earnings above the secondary threshold adds GBP 24,000 to the annual payroll budget across the four roles.
Example
A contractor compares taking a role as an employee on GBP 70,000 with invoicing the same work through her own company. The combined employee and employer contributions on the salaried option are what make the two arrangements look so different before the off-payroll rules are considered.
Example
A woman approaching retirement checks her contribution record and finds three missing years from a period spent abroad. She pays voluntary contributions to fill the gaps, which increases her state pension for the rest of her life.
Formula
Calculation
Employee contribution = (earnings up to the upper limit - lower threshold) x main rate + (earnings above the upper limit) x reduced rate
Employer contribution = (earnings - secondary threshold) x employer rate
Total employment cost = gross salary + employer contribution
The figures below use deliberately rounded illustrative rates and thresholds so the arithmetic is easy to follow; the current year's official figures should always be checked before running payroll. Assume a lower threshold of GBP 12,500, an upper limit of GBP 50,000, an employee main rate of 8% with 2% above the upper limit, and an employer rate of 15% on earnings above a secondary threshold of GBP 5,000.
Take an employee on a salary of GBP 60,000.
Employee contribution on the main band = (GBP 50,000 - GBP 12,500) x 8% = GBP 37,500 x 8% = GBP 3,000. Employee contribution above the upper limit = (GBP 60,000 - GBP 50,000) x 2% = GBP 10,000 x 2% = GBP 200. Total employee contribution = GBP 3,000 + GBP 200 = GBP 3,200, which is 5.3% of gross salary.
Employer contribution = (GBP 60,000 - GBP 5,000) x 15% = GBP 55,000 x 15% = GBP 8,250.
Total employment cost = GBP 60,000 + GBP 8,250 = GBP 68,250, before pension contributions. In other words, the advertised salary understates the cost of the hire by nearly 14%.Case study
Seen in the real world.
Wrenfield Tooling is a fictional engineering firm invented to illustrate how these costs land in a budget. It plans to grow its production team from eight to fourteen people at an average salary of GBP 38,000, and its draft budget shows an increase of 6 x GBP 38,000 = GBP 228,000.
The finance manager reworks it using the illustrative rates above. Employer contributions on each new hire are (GBP 38,000 - GBP 5,000) x 15% = GBP 4,950, so across six hires that is 6 x GBP 4,950 = GBP 29,700. Adding pension contributions at 3% of salary, another GBP 6,840, the real increase is closer to GBP 264,540.
Wrenfield delays two of the six hires by a quarter to keep within budget. The illustrative lesson is simple: payroll taxes are not a rounding error on a hiring plan, and headcount budgets built on gross salaries alone will always come in short.
Watch out
Common mistakes.
- Budgeting headcount on gross salary alone. Employer contributions and pension costs add a significant amount on top of every advertised salary.
- Assuming contributions work like income tax. The bands, thresholds and rates are different, and the employee rate falls rather than rises above the upper limit.
- Ignoring gaps in a personal contribution record. Missing years can permanently reduce state pension entitlement unless voluntary contributions are made in time.
Questions
People also ask.
Do employers pay National Insurance as well as employees?
Yes, and the employer charge has no upper limit, so it continues on every pound of salary above the secondary threshold.
Do the self-employed pay it?
Yes, under different classes with different rates, calculated through the self assessment tax return rather than through payroll.
Do contributions actually fund the state pension?
They fund it in the sense that current contributions pay current benefits, and an individual's record determines their own entitlement, but there is no personal fund set aside.
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