National Insurance changes: will you pay more?

Most workers will get a boost in their pay packets from next month thanks to a rise in the National Insurance threshold. However, many of us will end up paying more tax next year thanks to fiscal drag.

From 6 July, the threshold at which workers start paying National Insurance will increase by £3,000. It means less of workers' pay will be subject to National Insurance as they will earn up to £12,570 a year before they pay it - a significant increase from the current rate of £9,880.  

It means almost 30 million workers will benefit, including 2.2 million people who will be taken out of paying National Insurance altogether. 

This comes after a 1.25 percentage point increase in National Insurance in April to fund the new health and social care levy. From July you’ll pay 13.25% National Insurance on earnings between £12,570 and £50,270 and 3.25% on earnings above £50,270.

The to and fro on National Insurance may seem baffling. Let me spell out what it means for your pay packet.

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How much better off will I be after National Insurance changes?

Anyone earning below £41,389 will pay less National Insurance in July than before April.

If you earn £20,000 a year you will be about £291 better off, if you earn £30,000 a year you’ll be around £192 better off - and if you earn £40,000 a year you’ll be £103 a year better off.

For these people the threshold rise in July is worth more than April’s increased rate in National Insurance. Amid the cost-of-living crisis, a little extra cash in your pay is not to be sniffed at - it can mean extra financial cushioning. 

Alternatively, you may want to use these modest amounts to boost your pension or ISA contributions. Remember the impact of even the smallest of increases to your contributions. 

For example, if you earn £30,000 a year and get a 1% pay rise, rather than have an extra £16 in your pay packet (or £192 a year), increase your pension contribution from 8% to 9% and you could end up with an impressive £37,000 extra in your pension pot by the time you retire. (Based on a 30-year-old and assuming investment growth of 4% a year).

How much worse off will I be?

Anyone earning a salary higher than £41,389 will be worse off in July. 

If you earn £50,000 a year you will be £10 worse off, if you earn £70,000 a year you’ll be around £178 worth off - and if you earn £100,000 a year you’ll be £459 worse off. 

From April 2023, working pensioners will find themselves paying the health and social care levy of 1.25% as it will be separated from National Insurance and taken directly from salary. If you’re over the state pension age of 66 and still working, you will have to pay it, even though you don’t have to pay National Insurance. 

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Don’t forget fiscal drag

In April 2022, the personal tax allowance – the point at which you start paying 20% tax – was frozen at £12,570, while the threshold for paying higher-rate tax (40%) was frozen at £50,270. Neither will be increased again before April 2026.

It means 2.5 million workers could be dragged into paying the 40% higher rate of tax by 2024 because of what’s known as the ‘fiscal drag effect’.

Most of us see our wages go up each year so that they keep up with inflation – wage growth is currently 6.8%, according to the Office for National Statistics. But unless tax bands increase at the same time, you can routinely find yourself in a higher tax band than before, even though you’ve not had a proper pay rise that actually leaves you better off in real terms. This is ‘fiscal drag’.

Depending on wage growth over the next few years, workers are likely to end up paying more income tax. It can simply creep up on you if you don’t take action.

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Action to take against fiscal drag

Your pension is an effective shield against fiscal drag.

Pay a bit more into your pension and you can avoid paying 40% tax. It will leave you with less spending money each month but you still pocket the income - albeit in deferred pension form - as well as benefiting from tax relief.

Let’s say you earn £50,000 a year. If there’s 5% wage growth in each of the next two years, you’ll be on £55,125 and clearly over the £50,270 threshold - £4,855 will be liable to higher-rate tax.

To avoid this, you can make use of salary sacrifice on your workplace pension. You’d have to make a gross pension contribution of £4,855 but you’d receive 40% tax relief on that sum. It would require you to give up £2,913 of your take-home pay (£4,855 after 40% tax), assuming you have no other income or tax reliefs. But remember, you still pocket the income - just in deferred pension form.