National Insurance contributions: an introduction

National Insurance contributions (NICs) are a direct tax. Employees and self-employed people pay NICs once their earnings reach certain thresholds. Additionally, employers have to pay NICs on their employees’ earnings too. Unlike income tax, some of these thresholds are assessed by pay period (usually weekly or monthly), rather than over an entire tax year.

Unlike income tax, NICs are charged separately for each pay period and for each different job (for people who work multiple jobs). This means that two people with the same income, but structured in different way, may pay different amounts in NICs, though their income tax treatment would be the same (as income tax is assessed once across all jobs and cumulatively in a yearly period).

Additionally, NICs are only charged on earnings from employment and profits from self-employment, whereas income tax is applicable to other types of income too (for example, investment income). NICs are only payable by people over 16 years of age and under State Pension age.

The contributory principle

The payment of NICs entitles payers who have met certain conditions to receive contributory benefits. The biggest of these benefits is the State Pension. The link between payments and entitlement to benefits is known as the ‘contributory principle’ and was envisaged by William Beveridge in his report on social security and allied services, written in 1942 and partly implemented in 1948. Beveridge had hoped that contributory benefits, alongside other policies, would leave a residual and diminishing role for means-tested benefits.

However, several subsequent developments have eroded the strength of the contributory principle. For example, the role of means-tested benefits has tended to expand, while working-age contributory benefits have remained at a flat rate not designed to meet full household costs. Pension-age provision has not followed this trend, as the value of the State Pension has significantly increased since the 1970s.

Commentary on the contributory principle

The Social Security Committee highlighted in 2000 that the contributory principle was weakening – for example, due to the growth of means-tested benefits. The committee, as well as external academics, agreed that this was not necessarily a negative – for example, changes to Maternity Allowance in 1999 that removed NICs eligibility conditions “[created] only winners and no losers”, according to researcher Lewis Williams. However it did represent a move away from the contributory principle, as means-tested benefits are not based on a contribution record.

The National Insurance Fund

Unlike other taxes, most of the money raised through NICs does not go into the consolidated fund (the government’s bank account), but a separate pot of money, the National Insurance Fund (NIF). Money in the NIF is reserved exclusively for spending on social security benefits, such as the State Pension. A portion of money raised through NICs is allocated to the NHS before the rest is transferred to the NIF.

The NIF works as a pay-as-you-go fund. Therefore, receipts from contributions in one year are spent in the same year for contributory benefits. While there is a link between someone’s record of paying NICs and their entitlement to contributory benefits, there is no direct connection between the amount of NICs they pay into the NIF and the value of contributory benefits they are entitled to claim.

The NIF needs to maintain a working balance of 16.7% of estimated benefit expenditure to weather any fluctuations in contributions or expenditure (PDF). To maintain the working balance of the fund, the Treasury can also ‘top up’ the NIF with a grant (known as a ‘supplement’) by a specific percentage of expected benefit expenditure.

The last time such a supplement was needed was in 2015/16 (PDF). Since then, the NIF has operated with a growing surplus, which has meant no supplement has been required in subsequent years. However, the Government Actuary’s Department estimates that this balance will begin to reduce, and that by 2043/44, the NIF will reach zero. According to those projections, by that date existing contributions will not be sufficient to fund benefits for that year.

How are NICs receipts spent?

Most money raised through NICs is spent on contributory benefits (PDF). The biggest contributory benefit is the State Pension, which cost over £110 billion in 2022/23 (around 95% of payments out of the NIF).

Recent developments to NICs

In the 2019-2024 Parliament, the Conservative government implemented four key changes to NICs:

• In April 2022, the Health and Social Care Levy was introduced. Originally, it was based on a 1.25 percentage point increase to NICs for employers, employees and self-employed people. The levy was abolished by the Truss administration, effective from November 2022.
• In March 2022, the Johnson administration increased the thresholds of NICs for employees to align them with the main income tax thresholds. The government announced these thresholds would be maintained at the same level until April 2028.
• In October 2023, the Sunak administration announced a 2 percentage point reduction in employee NICs, and a 1 percentage point reduction in self-employed NICs.
• In March 2024, the Sunak administration reduced employee and self-employed NICs by two additional percentage points.
• In October 2024, the Starmer administration announced an increase in the rate of employer NICs, a reduction in the threshold at which employer NICs becomes payable, and an increase in the Employment Allowance, from April 2025.

Policy debate on NICs

Reforming individual elements

Over the past few decades, successive governments have altered the structure of NICs, bringing it into closer alignment with income tax. Many researchers believe further reform should occur.

For example, many (chiefly the Office of Tax Simplification (OTS)) suggest that NICs should move to an aggregated, cumulative assessment (PDF). Under this approach, someone would get one annual NIC assessment that took account of all the jobs they worked. This is how income tax operates. The OTS points out that some people would gain and others would lose from these reforms. It adds that the ‘gainers’ would generally be people on lower incomes.

Additionally, many have argued that the NICs differential between employment and self-employment was out of date with the modern workforce. The OTS recommended evening up NICs between employment and self-employment (PDF).

In 2017, the then Chancellor, Philip Hammond, said the disparity between employee and self-employed NICs was no longer justified, and announced an increase in self-employed NICs to begin to equalise them. However, a few days after the Budget, he announced that the reform would not be pursued, as it would conflict with the Conservative Party’s 2015 manifesto.

There have also been calls (primarily by the Intergenerational Foundation (PDF), which campaigns for intergenerational fairness) to begin applying NICs to people over the State Pension age. In 2016, the OTS said the exemption for people over the State Pension age needed closer examination (PDF). This reform has not been suggested by governments over the past few decades. However, it is important to note that if the Health and Social Care Levy had been implemented in full, it would have also applied to workers over the State Pension age. This would have been a clear change from the NICs model that the levy was otherwise going to adopt, as NICs only applies to workers under the State Pension age. This did not come to fruition, as the levy was abolished before its full implementation.

Merger with income tax

The decline of the contributory principle has led many to believe NICs have become ‘just another tax’ on income. Chief among them is the Mirrlees review, an influential report on the UK tax system published in 2011. There are still several significant differences between income tax and NICs, as noted above. However, the Institute for Fiscal Studies (IFS) argues these differences support the case for integration, rather than weaken it.

As far back as 2003, the IFS argued that the integration of income tax and NICs was a sensible economic choice. The Intergenerational Foundation has similarly called for the introduction of a “Common Personal Income Tax” to merge income tax and NICs.

The OTS, which has analysed the case for closer integration, has said significant administrative simplifications could occur (PDF). However, it acknowledged several obstacles. Many (such as the authors of the Mirrlees review) added that a merged tax would improve transparency and public understanding of the taxation of personal income in the UK.

However, successive governments have resisted the case for merger. Ministers have said that NICs are based on social insurance, which would make a merger difficult. Proponents of a merger, such as the IFS, also talk about the “formidable challenges” a merger would pose, particularly in relation to employer NICs. This is because an equivalent employer levy does not exist for income tax.

The Mirrlees review analysed the question of employer NICs. It considered the option of merging employer and employee NICs in a single charge or maintaining a separate employer levy, but adding another levy to non-employment income. The review describes both of these as difficult choices.,

In 2015, the OTS put forward another approach, suggesting the employer charge could be based on whole payroll costs rather than on the earnings of individual employees (PDF).