New bombshell for self-employed: pay 400% more NICs … or lose state pension

Jane Clark, a self-employed maths tutor who earns around £2,500 a year, faces a 400% increase in her national insurance contributions (NICs) if she wants to retain her right to a state pension.

That equates to an extra £588 a year, which is a good chunk of Clark’s earnings – and she is far from alone. Potentially, several hundred thousand self-employed people who earn below £6,000 a year will be clobbered, unless the government brings in measures between now and April next year to reduce the impact.

Philip Hammond had to ditch his grand plan to increase “class 4” NICs for the self-employed just a week after he announced it in the budget. It’s a spectacular U-turn – but it doesn’t mean the self-employed have got off scot-free.

While the chancellor’s latest announcement means middle and higher-earning self-employed people – those who would have been hit by the increase – are now off the hook for the time being, their less well-off counterparts are not so lucky.

The government is pressing ahead with the previously announced abolition of “class 2” NICs for the self-employed from April 2018. As things stand, this means many of Britain’s lowest-earning self-employed workers will either have to pay an extra £588 a year, or lose their entitlement to a state pension.

Tutors are just one of the groups likely to be affected by this little-known change, which could disproportionately impact women. Others who could be hit include those, for example, in hairdressing, and people working in the arts.

Clark is in her 50s and lives in the West Country, and while her earnings are relatively small, she and her husband are not solely reliant on her income – he receives a pension.

Class 2 NI is payable at the rate of £2.80 per week for the self-employed who earned more than £5,965 in 2016-17. Crucially, though, those who earn less than that can choose to pay class 2 NI contributions in order to gain entitlement to a state pension. That’s exactly what Clark does – she voluntarily pays £145.60 a year (ie, 52 x £2.80). But from April 2018 she won’t be able to do that – she will have to either pay class 3 voluntary contributions, at a cost of £733.20 a year at current rates, or “give up on a state pension”. That’s a 404% increase.

Clark told the Guardian the extra £587.60 represents a sizeable slice of her earnings. She says: “Until now, the low-paid self-employed have had, in some ways, quite a good deal via class 2 contributions. This will certainly affect many negatively by making it harder for them to accumulate pension rights.”

She adds: “It’s going to affect mostly women. I’d say probably older women whose husbands work or are retired, and who are suddenly going to have this huge change put upon them. For example, if you have a husband working who earns enough so that you don’t get tax credits. I’m not saying I’m terribly poor – my husband has a pension, and we do have money which we live off. It’s not in itself that there’s anything wrong with it – it’s just that no one has highlighted these changes, and maybe there should be a period during which they are phased in.”

This change only affects self-employed people whose earnings are below what’s known as the “small profits threshold” (SPT), currently £5,965. However, there are more people in that bracket than you might think.

A few days ago the Office for National Statistics revealed that in 2015-16 there were 967,000 people with an annual income from self-employment of less than £5,965.

It is important to make clear that not all of these people will be adversely affected. Those with profits below the SPT, but who are eligible for national insurance credits, would continue to build up qualifying years for the state pension. This typically includes people who receive certain benefits (eg, working tax credit or universal credit), parents of children under 12, foster carers and those receiving carer’s allowance.

If you are not eligible for NI credits, and want to protect your future entitlement to the state pension, you would need to pay voluntary class 3 contributions, says the government. The current rate is £14.10 a week or £733.20 a year.

Another Guardian reader got in touch to say that “nobody in the media” seems to have picked up on this, adding that many of the low-earners affected “will be people starting up and being self-employed for the first time, or those who can only work part-time because, perhaps, they have caring commitments for children, sick or elderly family members, or they work in low-paid sectors like the arts”.

Can it be true that the government is really hammering people earning just a few thousand pounds a year in this way? We asked the Low Incomes Tax Reform Group (LITRG) of the Chartered Institute of Taxation, and its technical director Robin Williamson confirmed this was the case. He told us: “If you’re opting into class 2 at the moment to preserve your state pension entitlement, from 2018 you’re going to have to pay five times more if you want to maintain that contribution. This particular group of people will be worse-off.”

But others will argue that even paying the increased £733.20 a year still gives the self-employed a very good deal. In simple terms, it means that, over 35 years, they would pay £25,600 at current rates to obtain the right to a full state pension, currently worth £8,093 a year.

Of course, the government may put transitional arrangements in place to mitigate the cost of the changes. As this week has shown, things can move fast in the world of NICs. Williamson reckons that if the government doesn’t do something, “there’s going to be another big outcry”.

HM Revenue & Customs says: “Abolishing class 2 NICs removed a regressive levy on the self-employed. We expect a very small proportion, around 2%, will choose to pay class 3 NICs to build entitlement to contributory benefits, such as the new state pension which is worth £1,800 a year. Choosing to do so is entirely voluntary.”

This £1,800 is the difference between the £8,093 new pension annual amount and the £6,203 basic state pension annual amount for 2016-17.

Jane Clark is not her real name

And fishermen don’t escape the net

The low-paid self-employed aren’t the only ones who face having to cough up more money because of the scrapping of class 2 national insurance contributions in April 2018. Others affected range from fishermen to people doing volunteering work overseas.

As we explain above, the self-employed who earn less than a certain amount, are able to voluntarily pay class 2 NI contributions to gain access to the state pension.

However, they are also paid by certain groups who are not necessarily self-employed in the UK, in order to gain access to contributory benefits. They include those working abroad, either on a self-employed or employee basis. They will need to pay class 3 voluntary NICs instead to protect their state pension record, following the abolition of class 2 NICs. On a BritishExpats.com website forum, one poster said: “It used to be an ‘excellent’ deal, now it’s just a ‘great’ deal.”

Meanwhile, the special rates of class 2 contributions which two other categories of people – share fishermen and volunteer development workers (those who take part in projects in developing countries) – are able to pay, will no longer be available in future.

Share fishermen are those who work in the UK fishing industry and are paid a share of the earnings, or profits, of the boat they work on. They can pay £3.45 a week. Those doing voluntary work abroad are able to pay £5.60 a week.