How the self-employed may miss out on the state pension
Low-paid self-employed workers workers, such as those running small businesses or actors and singers with seasonal jobs, may be stung with a 400% increase to national insurance contributions to access the state pension from April 2018.
The move comes as part of government plans to reform how the self-employed are taxed. A government spokesperson says: “To modernise the outdated and complex self-employed national insurance system for millions of people, Class 2 national insurance contributions (NICs) will be abolished in April 2018. This represents a tax cut for 3.4 million self-employed people of £134 on average per year.”
However, while this means those who earn £5,965 or more will no longer have to pay £2.80 a week in Class 2 national insurance contributions, those who earn less may face a hike to the voluntary contributions they pay, which are needed to be eligible for the state pension.
Moneywise investigates what’s been proposed and how it could affect you.
How the self-employed currently pay towards their state pension
It’s a complicated system but, as the table shows, all self-employed people pay Class 2 NICs, and those earning more than £8,060 a year also pay Class 4 contributions. These payments are taken in addition to any income tax due.
NIC payments are made via self-assessment tax returns, as opposed to the employed who have their NICs deducted from their pay automatically.
Self-employed national insurance rates for 2016/17
|Profit per year (i)||Class 2 NI payment due?||Class 4 NI payment due?||Total annual NI payment|
|£43,000 and above||Yes, at £2.80 a week||Yes, at 9% on profit between £8,060 and £42,999.99, and at 2% on profit of £43,000 and above||£3,145-plus|
|£8,060 to £42,999.99||Yes, at £2.80 a week||Yes, at 9% on profit between £8,060 and £42,999.99||£145.60 to £3,145|
|£5,965 to £8,059.99||Yes, at £2.80 a week||No||£145.60|
|£5,964.99 or under||
No, but voluntary contributions can be made at £2.80 a week
|No||£0 - but could pay £145.60 voluntarily|
(i)Profit is what you make once allowable expenses, such as office and travel costs or staff salaries, have been deducted. Compiled by Moneywise.co.uk.
In this year’s Budget, the government confirmed that Class 2 NICs will be scrapped from April 2018, and instead, the self-employed will just pay Class 4 NICs.
This is significant, because Class 4 NICs don’t typically count towards any state benefits, whereas Class 2 NICs enable entitlement to the basic state pension, the new state pension, contribution-based employment support allowance, maternity allowance and bereavement benefits – once you’ve earned a certain number of qualifying years for each benefit.
To make up for this, the government says it will reform Class 4 NICs so self-employed people can continue to build these benefit entitlements.
It ran a consultation on how this could work from 9 December 2015 to 24 February 2016, although a response – other than the announcement in the Budget – had yet to be issued at the time of writing.
What this means
As part of the government’s plans to reform Class 4 NICs, it’s proposed that Class 4 payments become payable once a self-employed person earns at least £5,965 in profit. But this begs the question of what happens to state benefit entitlements for those who earn less than this?
The government has proposed that when it comes to accessing the state pension, people either need to:
- gain qualifying years via national insurance credits, which although free, are generally only available for those on certain benefits, such as working tax credit or universal credit; or
- voluntarily pay for Class 3 NICs, at a revised cost of £14.10 a week.
The second option is a whopping increase of £11.30 a week – or just over 400% – compared to the current £2.80 needed for state pension contributions.
On bereavement support payments and employment support allowance, which cover periods when you’re unable to work, the government is also considering adding eligibility for these under Class 3 NICs – but, again, there’s the same problem about the pricier cost compared to Class 2 NICs.
The government is also considering using Class 3 NICs for low earners to build up access to maternity allowance. But, in recognition of the higher cost, the government has said that in this scenario it will consider requiring fewer Class 3 NICs than at present.
Why people are unhappy about it
The government says the aim of these reforms is to make self-employed NICs easier to administer and simpler to understand.
This is particularly important given consumer charity Citizens Advice says there is evidence that simpler tax systems improve understanding and personal entitlements, particularly among the self-employed.
But the jump in the amount some people may have to pay to access state benefits is worrying.
Martin Harmer, a 55-year-old self-employed surveyor and contractor from Launceston in Cornwall first flagged the issue to Moneywise.
While he isn’t affected by the potential changes as he earns over the £5,965 profit limit, as a former adviser at a Citizens Advice Bureau, he is concerned by the impact it may have on low earners. He says it’s a “very cruel cut”, which “unfairly penalises low-paid strivers who are really struggling”.
Citizens Advice warns that the move could result in fewer people saving for retirement. Its research shows that the number of people in self-employment has increased in recent years, but at the same time the number of self-employed people saving into a private pension has halved.
It adds that if it becomes much more expensive to cover shortfalls in state pension qualifying years, the self-employed will be less likely to pay for contributions, leaving them financially vulnerable when they retire.
Meanwhile, lobby group and charity the Low Incomes Tax Reform Group believes the proposals could result in more people relying on other benefits later in life. “If the cost of making these voluntary contributions is too high, no such contributions will be paid and the individual may end up more dependent upon means-tested benefits,” it states.
“Further, since the number of years of NICs required to achieve a full state pension has increased to 35 years, it is crucial that years spent in self-employment enable sufficient contributions to be paid. This would become even more important should there be a further increase in the number of years required to qualify for a full state pension.”
Citizens Advice argues that lower voluntary Class 3 NICs for self-employed people earning below the threshold would be more “likely to encourage them continue to build up their entitlement to contributory benefits”.
While the trade union for performers, Equity, adds that a lower rate for contributions, as with what is being proposed for access to maternity allowance, may be an alternative to the government’s proposals. Its members in particular may be negatively hit by the proposals.
Experts have also suggested that switching to Class 3 NICs may cause confusion given you don’t pay for these via self-assessment as you do with Class 2 NICs. Instead, Class 3 payments are made by monthly direct debit or by annual billing.
But for now it’s an anxious waiting game for many until the government decides what to do.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.