The Conservatives have been chipping away at national insurance, and say they want to abolish it altogether for the self-employed. But national insurance has traditionally been the way to build up a state pension – so where would this leave the people who work for themselves?
In common with most higher-income countries, the UK operates a social insurance system. In return for paying certain types of tax, you become entitled to claim various benefits from the state.
National insurance is a tax paid by people of working age on their earnings or profits. Some types act as social insurance, including class 1 contributions paid by employees and class 2 contributions paid by self-employed people. These contributions build your entitlement to claim a state pension when you retire.
However, the Conservative government abolished class 2 national insurance contributions. Instead, since April 2024, self-employed people with taxable profits of £12,570 or more get national insurance credits towards their pension.
Self-employed people with profits between £6,725 and £12,570 already get these credits rather than having to pay contributions.
Those with lower profits can opt into paying the contributions. However, it’s worth remembering that, under current rules, you need only 35 years of contributions or credits to get the full state pension (most people’s working lives span around 50 years).
Phasing out national insurance
If you are self-employed, you also pay class 4 national insurance contributions. These are purely a tax on profits – they do not carry any entitlement to claim the state pension or other benefits.
Class 4 contributions apply on profits above £12,570 and up to £50,270 at a main rate (6% since April 2024) and a lower rate of 2% on profits above that. The Conservatives, in their manifesto, pledge to reduce the main rate further in successive years until the tax is fully abolished from April 2029. This would not affect income tax, which self-employed workers pay at the usual rates on any profits they make.
Tax on earnings has been rising due to the freezing of the income tax personal allowance and higher-rate threshold until 2028. With wage growth, which has been strong in 2024, earnings cross these frozen boundaries and pull workers into higher bands (so-called “fiscal drag”).
Cuts to national insurance so far have, according to the Institute for Fiscal Studies (IFS), only partially offset income tax rises. The Conservative plan would continue this partial offsetting.
Cutting contributions is relatively painless in terms of the public finances. Contributions go into a “national insurance fund” where they are immediately used to pay state pensions (and some benefits).
But the fund has a surplus of around £80 billion, so the cuts are being financed by running down that surplus.
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The main rationale for the abolition of national insurance for the self-employed is to back “risk-takers and entrepreneurs”. However, of the 3.9 million self-employed people in the UK, one in ten are over state-pension age and so no longer pay national insurance contributions anyway.
What’s more, of the 5.6 million private sector businesses in the UK, 4.1 million are “non-employers”, in other words one person with no employees and unlikely to be a major source of growth.
Larger private businesses (with at least one employee) are more likely to be set up as companies rather than self-employed (technically “sole proprietors”). Only sole proprietors (and some partnerships) pay class 4 national insurance. So again, it seems unlikely that class 4 national insurance is holding back growth.
However, abolishing class 4 contributions can be seen as part of the Conservatives’ longer-term ambition to abolish national insurance, including for employees, and so simplify the tax system.
This is in line with the recommendations of the Mirrlees Review, commissioned by the IFS more than a decade ago to look at the whole tax system. The review argued that there are good reasons to operate a separate social insurance system, but that national insurance has so many anomalies that it is not working as originally intended. It recommended that national insurance be merged with income tax to be more efficient and transparent.
Paying contributions is not the only – or even the best – way of organising a state pension system. Many people in the UK already rely on national insurance credits rather than paid contributions to build up at least part of their state pension entitlement. Importantly, since 1978, this includes people doing unpaid work caring for young children and frail adults.
Some countries, including Canada, New Zealand and Norway, base state pensions on residency rather than the paid labour market. This implicitly acknowledges the value of unpaid as well as paid work and the human rights of those unable to work.
So, while the Conservatives may dangle an end to national insurance for the self-employed as a vote winner, there could be more serious grounds for rationalising the way the UK runs its state pension system.
Under current rules, when the national insurance fund surplus falls to one-sixth of the cost of paying for state pensions and the benefits it covers, there is an injection of money from general taxation. Eventually, if national insurance was completely abolished, state pensions would presumably be entirely financed through general taxes.
It would be naive to assume that the total tax burden would fall. Rather, it would shift and in the process most likely spread the costs more widely – with wealthier pensioners as well as earners contributing to the state pensions bill.