National Insurance is great. It builds up your state pension entitlement and helps pay for the NHS and other welfare services. Self-employed people who are sole traders pay National Insurance based on how much profit they make from their business. National Insurance, unlike income tax, is only payable by people who are aged 16 years or over, and are below the state pension retirement age.
When you're employed, either through your own limited company as a director, or more commonly as an employee of a larger company, your employment taxes are deducted at source (ie before it reaches your pay packet) through the Pay As You Earn (PAYE) stem. Limited company directors often choose to pay themselves a lower tax-efficient salary meaning they pay little, or no National Insurance and take most of their income through dividends.
When you're self-employed as a sole trader, you have to complete a Self Assessment to let HMRC know about your income and they will calculate the Income Tax and National Insurance you need to pay. But, first things first, you need to have a National Insurance number.
What is a National Insurance number?
Your National Insurance (NI) number is your personal identifier for the social security system. This identifier ensures that your National Insurance contributions and tax are properly recorded. If you don't think you have one, or you've lost it or forgotten it you can go online to Gov.uk to apply for a National Insurance number or for help to find a lost one.
How do I register for National Insurance when I’m self-employed?
When you register as self-employed with HMRC, this covers both Income Tax and National Insurance.
What National Insurance do I pay when I’m self-employed?
As part of the Treasury’s annual budget process, all employment taxes, including the thresholds which affect National Insurance Contributions (NICs) are reviewed. This means from 6th April every year, you need to be aware of the amount of NICs due on the profits made by your sole trader business.
The first thing to understand is that sole traders have different NIC rates to those of PAYE employees (such as limited company directors – who should read our article “How much should I take as a salary“).
There are two main classes of NICs which apply to sole trader (self-employed) profits:
- Class 2 NICs – payable as a weekly flat rate of £3.05 (for both the 2020/21 and 2021/22 tax years)
- Class 4 NICs – payable as a percentage of sole trader profits. Both are calculated as part of the annual Self Assessment process.
Class 2 NICs
For the 2021/22 tax year, you will need to pay Class 2 National Insurance if the profit made by your sole trader business is more than £6,515 (up from £6,474 in 2020/21). This amount is known as the ‘Small Profits Threshold’.
The Class 2 rate per week is £3.05, which you need to pay annually to HMRC through the Self Assessment process. So your Self Assessment liability to HMRC includes the Class 2 NIC of £158.60 for the tax year (this figure is the same for both the 2020/21 and 2021/22 tax years).
No National Insurance is payable on any profit up to the Small Profits Threshold. You may, however, wish to make voluntary Class 2 NI contributions, even if your profits are below the threshold, we'll go into this later in the article.
Class 4 NICs
For the 2020/21 tax year, you’ll need to pay Class 4 National Insurance if the profit made by your sole trade business is more than £9,500. This amount is known as the ‘Lower Profits Limit’ .
In the 2020/21 tax year, If your profits are £9,500 or more a year, you’ll pay Class 4 NICs of:
- 9% on profits between £9,500 and £50,000
- 2% on profits over £50,000.
The £50,000 amount is known as the ‘Upper Profits limit’ for 2020/21.
In the 2021/22 tax year, If your profits are £9,568 or more a year, you’ll pay Class 4 NICs of:
9% on profits between £9,568 and £50,2702% on profits over £50,270.The £50,270 amount is known as the ‘Upper Profits limit’ for 2021/22.
Class 4 NICs are calculated annually by HMRC as part of your Self Assessment. Your Self Assessment liability will include a calculation based on the amount of profit made by your sole trader business.
For Class 4 NICs, you’ll usually pay the amount due to HMRC every six months as part of your payment on account (31st July each year) and/or your final Self Assessment payment (31st January each year). The payment on account is usually an estimate.
Class 1 (Employer’s) National Insurance Contributions
As a sole trader, you usually don’t have to worry about Class 1 NI, unless you also have a job as an employee. However, if your sole trade business has any employees (not subcontractors, freelancers or yourself), then you'll need to run a payroll for your employees, and if they earn more than the National Insurance earnings threshold you'll need to make employer’s NICs for them as well as making the correct deductions for their employee's NICs.
The threshold for employer NICs works in the same way as employees. For every salary amount your employee earns above the weekly National Insurance earnings threshold, the employer has to pay NICs at 13.8%. This represents another PAYE tax your business has to pay.
If you have gaps in your National Insurance records, HMRC allows you to make voluntary National Insurance contributions.
Gaps may occur because you were:
- self-employed but did not pay contributions because of small profits
- living abroad.
If either of these circumstances apply to you, then you can choose to pay voluntary Class 2 contributions.
Or, gaps may have occurred because you were:
- employed but had low earnings (earning under £120 a week and not eligible for National Insurance credits)
- unemployed and were not claiming benefits
If either of these applies, you can choose to make voluntary Class 3 National Insurance contributions which are £15.30 a week for the 2020/21 tax year, or £15.40 a week for the 2021/22 tax year. However, this is a specialist area and you’ll need to take advice based on your individual circumstances. You’ll need to liaise closely with HMRC to ensure any voluntary contribution made is calculated correctly.
It may be beneficial to make voluntary contributions in order to gain qualifying years towards your state pension entitlement, contribution-based Employment and Support Allowance, Maternity Allowance, and Bereavement Support Payment, even if your profits are below the NI small profits threshold. Speak to an accountant to see whether this would be beneficial for you.
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