In the UK, there are a number of different types of tax and National Insurance classes to be aware of.
Unlike employees, it’s a business owner’s responsibility to know about, prepare for and pay National Insurance (NI) each year. To understand how National Insurance works for sole traders, you will need to research how each of the different NI classes, profit thresholds and NI rates work to see which applies to you.
For an overview of how National Insurance works for sole traders (and how it’s different from employees), keep reading. We’ll be covering exactly what NI is for, who has to pay it, how much you need to pay and how to set it up.
What is National Insurance?
National Insurance is an additional tax on income, originally created to help pay for things such as the State Pension.
There are different classes of National Insurance Contributions (NICs) and different people pay different amounts, depending on their work status. Most employees will automatically have their National Insurance taken from their salary each month, so they rarely have to worry about it. For sole traders (the self-employed), things are a bit different.
Who has to pay National Insurance?
Employees, employers and the self-employed all have to pay National Insurance on their earnings. However, there are thresholds your earnings need to meet before you have to pay. For employees, it’s all about salary. For the self-employed, it’s all about profits.
As a sole trader, you will need to pay National Insurance if you are:
- Over 16 years old
- Earn a profit of £6,475 and over within a tax year (2020-21)
Different classes of National Insurance
There are a number of different classes of National Insurance. The good news is that most sole traders only need to be aware of two of them.
- Class 1: This is paid by employees and employers and is calculated as a percentage of a salary. If you have been employed in the past, you likely will have paid this type of NIC before.
- Class 1A: This is a special NI rate paid by employers if employees get certain benefits with their job. For example, a company car.
- Class 2: This NI class is paid by the self-employed who earn over £6,475 profit in a tax year. This is the most common NI class to apply to sole traders.
- Class 3: Class 3 is for voluntary contributions. If you know you have gaps in your NI history, you can make additional contributions.
- Class 4: If you are self-employed and your profits are above £9,501, you will need to pay Class 4 NI in addition to Class 2.
How much National Insurance will I pay?
If you are a sole trader who doesn’t employ anyone, you will need to pay Class 2 and Class 4 if, or when you hit each threshold. However, if you have employees, you may also have to pay Class 1 on their wages as well.
The below rates apply to the 2020-21 tax year and may change in the future.
Class 2 NI
Class 2 National Insurance Contributions are charged at a fixed rate per week of £3.05. This is paid annually to HMRC through Self Assessment. This means that sole traders who earn over £6,475 a year must pay a total of £158.60 for the whole year.
Class 4 NI
Class 4 National Insurance is payable as a percentage of profits made above the threshold of £9,501.
- You will pay 9% on profits if you earn between £9,501 and £50,000
- You will pay an additional 2% on profits above £50,000 (the upper profits limit).
Class 4 NICs are usually paid through Self Assessment twice a year – as part of your Payment on Account in July and your Self Assessment payment in January.
Class 1 NI (for employers)
If you have employees (not counting freelancers/contractors), you will need to run payroll and pay employer NICs.
For each salary amount your employee earns over the NI threshold (currently £183 per week), you will need to pay NICs at 13.8%.
How do I pay National Insurance?
For most sole traders who only need to pay Class 2 and 4 NI, these contributions are collected through Self Assessment.
If you haven’t done Self Assessment before, it’s a tax return which you fill in each year to declare your earnings and expenses to HMRC. Most people do this with HMRC’s online service which is the quickest and most convenient way to do it.
Self Assessment is used to calculate how much income tax, National Insurance and student loan repayments (where applicable) you need to pay each year. If filing online, the system will automatically calculate how much you owe and split it into two payments in January and in July.
As National Insurance Class 2 and 4 are included in these annual payments, there’s no need to sign up to an additional service to pay National Insurance separately.
Paying National Insurance as an employer
For employers paying Class 1 National Insurance, this is collected a bit differently. This is collected through PAYE, both for employees and employers.
Employers must provide details of salary payments to HMRC whenever paying an employee. This is all done electronically through a new payroll scheme called Real Time Information (RTI). Employers must also pay their Class 1 NICs to HMRC each month when they report any payment information on their employees. If you are unsure about this, it’s best to enlist the help of a payroll manager or accountant.
While National Insurance can be a bit complicated, especially if you’re a brand new sole trader, you can learn more from HMRC’s website. Gov.uk has comprehensive guides on the different National Insurance classes and rates.
If you’d like further information, a great way to get help with your National Insurance and tax is to speak with a trained accountant. They will confidently be able to answer any of your questions as well as handle all of your tax work for you if needed.