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Monday, 16 November 2015

NATIONAL INSURANCE RISE FOR MILLIONS

National Insurance contributions will be going up by an average of 15% for around six million people in April. The lower the earnings the bigger the percentage rise. Technically this does not break the Government’s election pledge – made four times in the Conservative Party Manifesto 2015 – that “we will not raise VAT, National Insurance contributions or Income Tax”. The Treasury told me that the pledge only applied to main tax and National Insurance rates and in any case this increase had been announced by the previous government and so was outside the pledge.

Why?
The rise is part of the introduction of the new State Pension. From 6 April new contributions to State Second Pension (S2P or as it used to be called SERPS) will end. So no one will be able to ‘contract out’ of S2P in favour of their own pension at work. Until April those who do contract out of S2P get a rebate of 1.4% off their National Insurance contributions (NICs) bringing them down generally from 12% to 10.6%. (NB the exact calculation is complicated - see Note for Nerds below). When S2P disappears in April so will the rebate. 

Who?
The people affected all pay into a final salary (or career average) pension – nowadays called ‘defined benefit’ or DB schemes. These have been cut back by employers in recent years and around one million workers employed by about 2500 private sector firms pay into one. About 5 million do so in the public sector.

How much?
The rebate is 1.4% of a band of earnings between £112 and £770 and when it ends someone on average earnings of £25,000 will pay an extra £5.16 a week in NICs. That will put up their net weekly contributions from £33.93 to £39.09 an increase of 15.2%. Someone on minimum wage will see their NICs rise from £11.38 a week to £13.56 – an increase of £2.18 or 19.2%. The £2.18 extra NI will take them 20 minutes to earn.

The maximum NI rise is £479.02 a year (£9.21 a week or £39.92 a month) which applies to anyone earning more than ££770 a week or £40,040 a year.

The change will wipe out the 1% pay rise scheduled for many of the 4.5 million public sector workers from April. Anyone with current gross pay of £22,436 or more will end up worse off. For example, someone paid £30,000 a year will get a pay rise of £300. They will gain from the change in the personal tax allowance leaving them paying £20 less tax in the year. But the extra £36 NI on their pay rise and the loss of the £374.46 contracted out rebate will leave them £54.46 a year worse off despite the pay rise. That is a cut in their net pay of 0.23%.

Someone earning £15,000 gross will get a pay rise of £150 a year and pay £50 less tax. But the NI rebate loss and their higher pay will see NI contributions rise by £146.46. So they will keep just £53.54 of their £150 pay rise. That is a rise in their net pay of just 0.4%.

The biggest loss will hit someone earning £40,040 a year. They will get a pay rise of £400.40 but will end up £126.68 worse off - a cut of 0.41% in their net pay. Above £46,059 a 1% pay rise would lead to a net gain in pay.

These calculations do not take account of pension contributions or any changes which may be due in them from April.  Nor do they take any account of benefits or tax credits.

Will it change?
These calculations are based on 2016/17 NI rates and thresholds announced on 25 November 2015. Normally the lower thresholds go up each year with CPI inflation. As that is around zero there was no change. So the prediction I made some weeks ago remains – National Insurance for 5.5 million people is going up in April by an average of 15% compared with what it would have been if the new scheme had not been introduced.

Employers too
The change will not just affect employees. It will also mean higher NI payments by employers who have a contracted out salary related pension scheme. The rebate is currently 3.4% off a standard 13.8% rate. That will end from 6 April and employers will face a rise in the NI they pay on average salaries of more than one third. Private sector employers can make changes in the pension scheme to recoup the cost of the rise in NI contributions by reducing scheme benefits or increasing employee contributions. They can do that without consulting scheme trustees using what is called a 'statutory override'. To find out more search that term in Google. Some have already said they will do that. Employees of British Airways have told me that it will recoup the whole extra NI cost by raising their contributions inn its pension scheme, costing them about £100 a month. 

Public sector employers however must bear the cost. The Treasury estimates (p.64 line 18 in table 2.1) it will add £3.3 billion in 2016/17 to the pay bill of the whole public sector. The NHS Confederation in particular expects the NHS in England and Wales to face £1.1 billion a year in extra expenditure. The Local Government Association estimated the change would costs local authorities in the Local Government Pension Scheme an extra £700 million a year. 

Response
The Government says that the rise will be more than paid for by the higher rate of state pension which is earned. Every year of National Insurance which is paid will earn almost £4.45 a week in new State Pension compared with £3.97 a week under the old (current) system. But even that is only true until the full new state pension is reached, normally after 35 years contributing under the new system. After that there could be another 15 years or more paying National Insurance and gaining nothing. In that sense NI is just a tax on earned income. And for six million it is going up in April.

Note for nerds
The main standard rate of National insurance is paid on a band of earnings from £155 to £815 a week. But the contracted out rebate of 1.4% is calculated on a different band from £112 to £770 a week. Don’t ask! That complicates the calculation of the effects. The figures in versions of this blogpost lower than 1.50 understate the effect.

A shorter version of this blog was first published in the Money Box newsletter for 23 October 2015. Subscribe to the newsletter.

28 March 2016 
version 1.75 earlier versions may contain inaccuracies