What it means
The National Insurance system was set up so that people who pay in build up entitlement to certain benefits, including the state pension, jobseeker support and maternity allowance. Money is paid into the National Insurance Fund and a share also helps fund the National Health Service.
Unlike income tax, your contributions record determines which benefits you can claim. Contributions are divided into classes.
Class 1 is paid on employee earnings, with a part paid by the employee and a part by the employer. Class 2 and Class 4 apply to the self-employed, and Class 3 is a voluntary payment used to fill gaps in a record.
Rates and thresholds are set by the government and change from time to time, so any calculation should use the figures published for the relevant year. In general, contributions begin once earnings pass a threshold, and a lower rate often applies above a higher threshold.
Employers may also qualify for allowances that reduce their bill. For employers, the contribution is an extra cost of employment that must be included in budgets, pricing and hiring decisions.
A salary of $60,000 does not cost $60,000, because employer contributions and pension payments sit on top. Payroll teams collect and pay the amounts to the tax authority through the payroll system.
Employees see their share on the payslip, shown separately from income tax. Gaps in a contributions record can reduce a future state pension, so people with career breaks or time abroad sometimes choose to pay voluntary contributions.
Contributions also differ from income tax in who benefits. Because they are linked to a benefits record, they are often described as a form of insurance, though in practice current contributions largely pay for current benefits.
The distinction matters when you design a pay package for staff who ask how much they take home.
In practice
Real-world examples.
Example
A small design agency hires its first employee on a salary of $48,000. The founder adds the employer contribution to her budget and finds that the real cost of the hire is several thousand dollars above the headline salary. She also builds in the cost of the employer pension payment.
Example
A freelance photographer pays contributions based on her annual profit instead of a salary. She sets aside a percentage of every invoice so she can pay the amount when it falls due. This avoids a cash shortage at the tax deadline.
Example
A manager who spent three years working overseas checks his contributions record. He learns he has a gap that could reduce his state pension and decides to pay voluntary contributions to fill it. He compares the cost of the payment with the extra pension it would earn.
Formula
Calculation
Contribution = (Earnings - Threshold) x Rate
The rates and thresholds below are hypothetical and shown in dollars for illustration, because the real figures are set by the government and change over time.
Suppose an employee earns $4,000 a month, the employee threshold is $1,000 a month and the employee rate is 8%. Employee contribution = ($4,000 - $1,000) x 0.08 = $240.
If the employer threshold is $900 and the employer rate is 15%, employer contribution = ($4,000 - $900) x 0.15 = $465. The total cost of the contributions for that month is $240 + $465 = $705, of which the business bears $465 on top of the salary.Case study
Seen in the real world.
Thistlewood Bakery is an illustrative, fictional business with 12 staff. The owner priced her wholesale contracts using wages alone and was surprised when profits fell short of her forecast.
Her accountant showed that employer contributions added about 10% to the payroll cost on top of wages. After rebuilding her price list to include the true employment cost, margins returned to target.
In this illustrative story, the owner also learned that an employment allowance could reduce her bill if she qualified, and she applied for it. The case shows why labour cost forecasts should always include the employer's share. The owner also set a reminder to check the published rates each year.
Watch out
Common mistakes.
- Budgeting only for salary and forgetting employer contributions, which are a genuine extra cost.
- Assuming National Insurance is the same as income tax, when it has separate rules and builds benefit entitlements.
- Using last year's rates, when thresholds and percentages are set by the government and change, sometimes mid-year.
Questions
People also ask.
Who pays National Insurance?
Employees, employers and the self-employed, each under their own class and rules.
What does it pay for?
It helps fund benefits such as the state pension and, in part, the health service.
Can I pay extra to fill gaps?
Yes, voluntary contributions can fill missing years in your record, subject to the rules in force. Check the official guidance on deadlines before paying.
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