How do I pay National Insurance as a Sole Trader?
It’s not often I see fear in a client’s eyes. This happened recently, though, when I casually mentioned National Insurance. The chap concerned had just gone freelance, after carefully planning his transition from employee to free spirit. Somehow, in all the excitement, a crucial element had escaped his notice. Understandably so, I think. After all, nobody who creates a business has a burning desire to understand the National Insurance (NI) system. However, a basic knowledge of how NI works, and what you need to pay and when, will help you now and when you reach state retirement age.
In this post, I’ll explain this unnecessarily complicated tax and also share some tips on paying it if you’re self-employed.
What is National Insurance?
When it was first introduced in 1911, National Insurance was indeed an insurance scheme. Contributors were rewarded with payouts if unable to work or once they’d reached the state retirement age (70, at the time). The method of recording contributions was through stamps affixed to a card, which is why you’ll sometimes hear people refer to paying your stamp.
It’s since become far more sophisticated and there are now six types of National Insurance contribution. Thankfully, as a sole trader, you need only concern yourself with two of them:
Class 2 National Insurance
This is a fixed weekly amount of £3, regardless of your income. You’re not obliged to make Class 2 contributions unless your profits1 exceed £6,365. Nevertheless, it could be worth making voluntary Class 2 contributions. Why on earth would you pay more tax than necessary? Well, because this affects your state pension entitlement. To qualify for the full state pension, you need to have made 35 years’ NI contributions. Any gaps reduce the amount you’ll receive. So, paying £156 per year now could boost your income significantly in the future. Additionally, you need to have made Class 2 contributions to be eligible for other benefits, such as Employment and Support Allowance (the only sick pay you’re entitled to as a sole trader).
Class 4 National Insurance
These contributions behave more like a tax. Class 4 contributions are paid as a portion of your profits, so what’s left over once you’ve deducted any allowable expenses from your turnover. You’re liable for Class 4 NI payments if your profits exceed £8,632. You’ll pay 9% on profits from £8,632-£50,000, and 2% on profits above that amount. These contributions aren’t linked with state benefits.
To recap:
- Class 2 if your profits are £6,365 or more a year and
- Class 4 if your profits are £8,632 or more a year
- You pay £3 per week (£156 per year) for Class 2 and
- 9% on profits from £8,632 – £50,000 for Class 4. It drops to 2% on profits above £50,000.
How do I pay National Insurance?
Fortunately, this part is straightforward – and you no longer have to collect stamps on a card. Both Class 2 and Class 4 contributions are paid along with income tax through your self-assessment tax return. As you probably know, this is due by 31st January – both the return itself, and your payment.
You stop paying any NI contributions once you reach state retirement age, although you’re still liable for income tax.
How can I calculate my National Insurance liability?
The best way to deal with tax returns is to prepare well in advance. The tax year ends on 5th April, so you have almost 10 months to do some calculations and start saving, if you haven’t already put some money aside. StepChange has created a useful online calculator to give you clarity on what you’ll need to pay. For example, if your turnover is £30,000 and your business costs are £2,000, you’d pay:
- Class 2 – £156
- Class 4 – £1743.12
- Income tax – £3099.96
That’s a total of £4999.08.
As a sole trader, your income probably fluctuates. It’s worth using this calculator each month to ensure that you’re not taking too much money out of the business. Nobody enjoys saving for tax, but a monthly sacrifice is better than a big bill just after Christmas. Remember, Class 2 contributions are fixed at £3 per week, so it’s easy-peasy to budget for this amount. Think of it as an annual subscription of £156 that you pay every January.
Conclusion
The Government has promised to overhaul National Insurance and a review is currently in progress. Given everything else that’s going on, this is unlikely to be a priority. In the meantime, using the calculator and setting aside your £156 should keep you on track. And you might even get a state pension when you’re 95.
Key Points
- turnover minus allowable expenses [↩]
How to Make Tax Less Taxing
Last year, the most popular time to submit personal tax returns online was between 4pm and 5pm on 31 January, just hours away from the deadline. During this period, the Inland Revenue received 17 submissions every second. Not everyone made it in time, though. Excuses included: “My mother-in-law is a witch and put a curse on me” and “I’m too short to reach the postbox.”
January might seem ages away, but now is the best time to make a start on your tax return. Although it’s customary to leave self-assessment to the last minute, you can save yourself some stress (and maybe even a few quid) by getting going right away.
In this post, I’ll explain three tactics for making the self-assessment process less taxing.
1. Calculate your tax liability now and start saving
Even if you don’t want to actually submit your tax return now, it’s worth at least working out how much you owe. Having a rough idea of the amount allows you to start putting aside money. If the total comes to £3,000, you can save £300 each month between now and January, rather than having to find a big chunk of money immediately after Christmas. The longer you leave it, the bigger the amount you need to find in one go.
2. Get organised with your paperwork
Completing the form is much more straightforward if you can easily access all the necessary information. Make sure you save:
- Payslips
- P60
- Dividend vouchers
- Records of any other income
- Running total of turnover and overheads for sole traders
If you’re hopeless with paperwork, scan everything and keep it in Dropbox or Evernote. Your future self will be delighted you made the effort.
Software such as TaxCalc stores all your standard details and automatically transfers them to your latest tax return each year. It also includes a What If? feature so you can see the tax implications of different scenarios.
A screenshot of TaxCalc
3. Pay Your Tax Monthly
It might seem perverse to pay your tax earlier than strictly necessary. However, this can make your finances more manageable. You won’t get any benefit from holding onto your money if you need to dip into your overdraft to cover the bill in January.
If you’re self-employed, you can use HMRC’s ready reckoner to calculate your likely tax bill and then create a budget payment plan. You decide how much you want to pay each month (or week). You still need to pay any tax outstanding by the deadline of 31st January.
Conclusion
In 2018, almost 750,000 people submitted their tax returns late, incurring penalties and interest:
- 1 day late – £100
- Up to 3 months late – £10 for each additional day (capped at 90 days) in addition to the initial £100 fine (up to a maximum of £1,000)
- 6 months late – either £300 or 5% of the tax due (whichever is higher) in addition to the penalties above
- 12 months – an additional £300, or 5% of the tax due, in addition to the above penalties. In some cases, you could be fined 100% of the tax due, thereby doubling your bill.
By getting ahead of yourself, you can have a much happier and wealthier New Year.
Image © Brian Jackson – stock.adobe.com
How to Make the Most of the New Tax Year
Unlike me, you’re probably not excited by the new tax year. However, this is a great opportunity to reassess your financial situation and then reward yourself with chocolate. Every April 6th, your tax allowances are adjusted and maximum contributions reset.
In this post, I’ll explain what’s happening this year with tax allowances, pensions, and ISAs.
ISAs
The overall maximum ISA contribution remains unchanged at £20,000. So, you can save or invest up to this amount across cash, stocks & shares, and Innovative Finance ISAs.
If you’re still under 40, you can use part of your allowance for a Lifetime ISA (LISA). This helps you either buy your first home or put aside money for retirement. Save the maximum of £4,000 this year and the Government tops it up to £5,000.
Those of you who are even younger (0-18) can pop £4,620 into a Junior ISA.
You can’t carry forward any unused ISA allowances to future years, so work out a plan now if you want to maximise the tax advantages before 5th April 2020.
Pensions
Unlike ISAs, you’re allowed to carry forward unused pension allowances for up to 3 years. Usually, you can contribute up to £40,000 or the value of your salary (whichever is lower) to your pension pot each year. You then receive tax relief on that amount. If you’re a basic-rate taxpayer, a £3,000 contribution becomes £3,600. The Government essentially refunds the tax you’ve paid on that income. Higher- and additional-rate taxpayers get relief at 40% and 45% respectively, although you often need to reclaim this through your self-assessment return.
If you’re an employee who’s likely to move into a higher tax bracket next year, it could be worth deferring your pension contributions to ensure you benefit from the extra relief. For more information on carrying forward your pension allowance, take a look at the Pensions Advisory Service guide.
Anyone who’s self-employed through a limited company can normally make unlimited pension contributions from the business, regardless of how much you pay yourself as a salary. You mustn’t, however, exceed your turnover from the year. Although you don’t get tax relief, it’s tax deductible. Corporation tax isn’t payable on the amount you put in your pension.
Even if you’re not currently earning, you can still contribute £2,880 into a pension. Tax relief then brings this amount up to £3,600.
Tax Changes for 2019-20
If you’re wondering how to find some spare cash to invest in your ISA or pension, you might have a pleasant surprise. In the year 2019-20, the personal allowance – the amount you can earn tax-free – rises from £11,850 to £12,500. The higher rate threshold above which you pay 40% is also increasing to £50,000. Some workers could see an extra £500 in their bank account over the year.
The National Insurance (NI) threshold has nudged up, too. You can now earn £8,632 (up from £8,424) before you need to make NI contributions of 12%. Once you earn more than £50,000, you pay 2% above that amount. This threshold has risen from £46,500, so anyone earning a salary between those two amounts will see a larger NI deduction from their pay packet.
Try the Which? tax calculator to see how much you should be paying. Calculators are available for previous years, too, to help you make a comparison. Which? also offers a comprehensive guide on all the personal tax rates for 2019-20.
Conclusion
Depending on your salary, then, you might have some extra money this year. Have a think about whether you can make it work harder for you by using some of the ISA and pension tax incentives outlined above. Even if you invested just £25 each month, this could grow to £3,600 over 10 years1 Don’t forget to pay yourself first.
This post is for information only and does not constitute financial advice.
Image © Adrian – stock.adobe.com
- Based on a stocks & shares ISA with a return of 5%. This calculation includes annual charges of 1.25% but does not take account of inflation. [↩]