What do the NI rate cut changes mean for both the employed and the self-employed? And what action do you need to take, if any? Natasha Crockatt from our Payroll team explains below.
Classes 2 & 4 currently
The self-employed currently pay two classes of NI contributions – Class 2 and Class 4. Class 2 contributions are the mechanism by which they build up entitlement to the state pension and Class 4 contributions are profit-related contributions which currently confer no benefit entitlement. However, this is to change as from 6 April 2024 Class 2 contributions are to be abolished.
For 2023/24, the self-employed pay Class 2 NI contributions at the rate of £3.45 per week for each week of self-employment if their profits exceed the lower profits threshold, which at £12,570 is aligned with the personal allowance, and the payment thresholds for both Class 1 and 4 NI.
Like their employed counterparts, self-employed with low earnings can “earn” a qualifying year without actually paying Class 2 contributions. If their profits fall between the small profits threshold of £6,725 and the lower profits threshold, they are treated as having paid Class 2 contributions at a zero rate, giving them a qualifying year.
The self-employed whose profits are less than £6,725 are not liable to pay Class 2 contributions, but can opt to do so voluntarily. At £3.45 per week this is a much cheaper option than paying voluntary Class 3 contributions at £17.45 per week.
Class 2 contributions for 2023/24 are payable via self-assessment and must be paid by 31 January 2025.
Changes from April 2024
Compulsory Class 2 contributions will be abolished from 6 April 2024, and from that date, self-employed individuals will only pay Class 4 contributions where their profits exceed the lower profits limit of £12,570. Class 4 contributions are payable at the main rate where contributions fall between the lower profits limit and the upper profits limit, set at £50,270, and at the additional rate on profits in excess of the upper profits limit. The main Class 4 rate is set at 9% for 2023/24, but is reduced to 8% for 2024/25. The additional rate is 2% for 2023/24 and remains at this level.
From 2024/25, the self-employed will continue to secure a qualifying year where their earnings exceed £12,570 per year. The position for self-employed earners with low earnings is maintained, and those with profits between £6,725 and £12,570 will receive an NI credit giving them a qualifying year for zero contribution cost.
The self-employed with profits below £6,725 for 2024/25 will still be able to make voluntary contributions at the 2023/24 Class 2 rate of £3.45 per week.
The abolition of Class 2 contributions will save the self-employed with profits in excess of the lower earnings threshold £179.40 per year, while the reduction in Class 4 will save them up to £377 per year. The self-employed with profits lower than £6,725 should check their NI record and if they do not have the 35 qualifying years needed for a full single-tier state pension, or the ten years needed for a reduced state pension, they should consider paying voluntary contributions at the Class 2 rate. This is a good deal and considerably cheaper than paying Class 3 contributions at £17.45 per week.
The Chancellor also announced a 2% reduction in the rate of primary Class 1 contributions payable by employees. However, rather than waiting until the start of the 2024/25 tax year to implement the cut, it takes effect from 6 January 2024.
Primary Class 1 contributions are payable by employees at the main Class 1 rate on earnings between the primary threshold (£242 per week, £1,048 per month, £12,570 per year) and the upper earnings limit (£967 per week, £4,189 per year, £50,270 per year) and at the additional rate on earnings above the upper earnings limit. The employed whose earnings are between the lower earnings limit (£123 per week, £533 per month, £6,396 per year) and the primary threshold are treated as paying Class 1 contributions at a zero rate, giving them a qualifying year for state pension purposes.
The main Class 1 rate is 12% from 6 April 2023 to 5 January 2024 and 10% from 6 January 2024 (remaining at 10% for the 2024/25 tax year). The additional Class 1 rate is 2% for both 2023/24 and 2024/25.
The reduction in the main rate of Class 1 contributions will save an employed earner up to £188.46 in 2023/24 and up to £754 in 2024/25 in Class 1 NI contributions. While welcome, the freezing of the payment thresholds until April 2028 reduces the impact of the cut in real terms.
Directors have an annual earnings period regardless of their actual pay interval, and as a result, their contributions for the year are calculated on an annual basis, using the thresholds and the annual Class 1 rates. Where a rate changes in-year, as is the case for the 2023/24 tax year, the calculation of a director’s NI becomes more complex. The impact of the in-year cut depends on whether the director’s NI is calculated on a cumulative basis using the annual rates and thresholds, or whether the alternative arrangements are used.
Where a director’s NI is calculated cumulatively, nothing is payable until the primary threshold is reached; contributions are then paid at the main rate until earnings for the year reach the upper earnings limit, and thereafter at the additional rate on all further earnings in the tax year.
Like PAYE, the approach is to work out the contributions due on the earnings for the tax year to date and deduct those already paid to arrive at the contributions due on the particular payment of earnings. For 2023/24, contributions are calculated using 12% for months 1 to 9 inclusive (6 April 2023 to 5 January 2024). Thereafter, year-to-date contributions are calculated using the composite annual rate of 11.5% for 2023/24.
If the alternative arrangements are used, the director’s contributions are calculated in the same way as for other employees, i.e. for each pay period by reference to their earnings for that period. However, a calculation must be performed on an annual basis when the director is paid for the last time in the tax year, with the balance of contributions due for the year deducted from the final payment (or refunded to the director if they have paid too much). The prevailing rate is used to work out the contributions each time the director is paid, i.e. 12% for payments made between 6 April 2023 and 5 January 2024 and 10% for payments made between 6 January 2024 and 5 April 2024. However, when performing the annual recalculation, the composite rate for 2023/24 of 11.5% must be used.
We can advise on knowing how to deal with the in-year rate change when calculating directors’ NI contributions and the need to use the composite annual rate of 11.5% from month 10 onwards where contributions are calculated cumulatively and for the annual recalculation where the alternative arrangements are used.
As there are no changes to the secondary thresholds or rate, the impact on employers will be to ensure the in-year change is correctly handled by the payroll software.
If software cannot be updated in time for the first payroll following the change, you must ensure that it is addressed before the end of the payroll year so that employees pay the right NI for the year as a whole.
Both the employed and the self-employed will save money after the changes, but the frozen payment thresholds mean this won’t be as generous as it first appears. As an employer, you should be aware of the need to update your payroll software and when to use the composite annual rate for calculating directors’ earnings.
Contact our team for any further questions relating to this and other National Insurance related queries.