Why is National Insurance for Directors calculated in a different way?
The reason Directors’ salary is subject to a different method of calculating National Insurance is because of the possibility that by structuring their remuneration package in a certain way (e.g. uneven salary/bonus amounts with some months having higher amounts than others), it would be possible for Directors to manipulate the system to defer or even avoid National Insurance contributions.
How is National Insurance for Directors calculated?
There are 2 methods that can be used to calculate National Insurance contributions for Directors:
The normal method: Using this method, the Director will not start paying National Insurance contributions until their total earnings to date have exceeded the total annual National Insurance threshold. This can be confusing for some new Directors especially those where the salary is such that it takes a couple of months to exceed the threshold. In this case, for the first few months of the tax year, there will be no National Insurance contributions to pay but then eventually the NI kicks in. To help our clients plan ahead, we give them a heads up when the NI is due to kick in along with an explanation/breakdown.
The alternative method: Using this method, the Director pays National Insurance in each pay period in the same way that a normal employee would i.e. contributions are based on the pay in that period and not the total earnings to date, and the threshold in each pay period is the equivalent amount per pay period and not the total annual threshold. However, for the final payment in the tax year, an adjusting calculation is made to work out whether based on the total earnings to date, the Director owes more or less in National Insurance contributions and an adjustment to the NI due is made accordingly. Although the alternative method can seem more straightforward because it is similar in calculation to the way that normal employees pay NI, it can catch payroll practitioners and Directors off guard when the status of the Director changes e.g. when the Director leaves employment during the tax year.
I am a Director whose annual salary is £12500 per annum (i.e. tax free allowance for 2019/20) and have noticed that I have not paid any National Insurance contributions to date. When do the National Insurance contributions kick in?
If using the normal method, the Director gets all their National Insurance allowance up front and will not pay contributions until the earnings for the year reach the NI threshold, which for the tax year ending 5th April 2020 is £8632. Therefore, since the monthly salary in this case would be £1041.67, the threshold amount would be exceeded in: £8632 (annual threshold amount) divided by £1041.67 per month = 8.3 i.e. after month 8 (November 2019). Therefore, the Director can expect National Insurance contributions to start in December 2019 and continue up to March 2020.
What happens to National Insurance contributions when an employee is promoted to a Director or ceases to be a Director during the tax year?
Once an employee has been processed using Directors National Insurance rules (i.e. National Insurance contributions calculated on a cumulative basis) the calculation cannot be changed back to the normal employee one until the start of the following tax year. In other words, even if the employee is no longer a Director, their National Insurance contribution calculation will be based on total earnings to date and the necessary adjustment calculation will be made when the final payment for the tax year is made.