I was on a train recently and opposite me were two old ladies bemoaning the State Pension (or the state of their pensions). One of them said:
‘I paid in for years and now it is just paying me back.’
It took every fibre of my being not to point out that her contributions paid for her parents’ state pensions (which would have been cheap as they wouldn’t have lived long) and that in fact my contributions were paying for her current pension. In fact I could have pointed out that my children will end up paying for my State Pension but on that basis I remain suspicious that it won’t exist by then.
But I bit my lip because there is nothing worse than being sat opposite a pension nerd on a train.
For most of the last century, National Insurance was a stamp.
An actual, physical stamp. Every week, working people bought one and stuck it onto a card. When the card was full you handed it in and began another. People spoke, and a few old people still do, of having “stamped up” for forty years, as though somewhere a stack of stamps was quietly accumulating with their name on it.
There was no stack. There never has been.
The stamp did something rather clever, though. It created a powerful and lasting feeling that you were paying into your own personal pot: a fund, built up over a working life, that would one day be handed back to you as a pension. It is one of the most durable beliefs in British life. It is also a fiction. National Insurance has always been pay-as-you-go. The money you hand over today isn’t stored up for your future. It’s spent, more or less that afternoon, on today’s pensioners and today’s services. When your turn comes, you’ll be paid by whoever is working then.
Once you see that, a more awkward question arises. If National Insurance isn’t really a contribution to a fund with your name on it, then what is it?
The honest answer is that it’s a second tax on your income. It sits alongside income tax, does much the same job, and gets away with it under a different and more reassuring name.
The Institute for Fiscal Studies, which has picked over this for decades, is blunt about the design. It calls it “patently absurd”: two separate taxes on the same earned pound, with different thresholds, different rules and different assessment periods, run as though they were strangers to one another.
So why keep them apart? The uncomfortable answer, and it’s made by critics right across the political spectrum, is presentation. Two smaller-sounding taxes are easier to swallow than one large one. A government that wants to raise the tax on your earnings can lift National Insurance and say, with a straight face, that it hasn’t touched income tax at all.
And the split isn’t merely cosmetic. Because National Insurance is technically its own creature, it comes with quirks that income tax doesn’t share. Earnings above state pension age escape the employee charge altogether. The self-employed pay less than the employed. And, importantly for a good number of the people we advise, National Insurance falls on earned income, on wages and self-employment, but not on the unearned kind: rents, dividends, pensions in payment, savings interest. Two people with identical incomes can pay very different amounts, depending entirely on where the money comes from.
Every so often a Chancellor stares at all this, agrees that it’s ridiculous, and proposes merging the two into a single honest tax. George Osborne did precisely that in 2011. Then they look harder at what a merger would expose, a single headline rate on income that would look considerably higher than either tax does alone, and at who would suddenly start paying, chiefly pensioners and landlords who currently don’t, and the idea goes quietly back into the drawer.
Which is the real reason the “patently absurd” system survives. Not because anyone can defend it, but because the absurdity is useful. It keeps the true cost of taxing income a shade blurrier than it would otherwise be, and it spares governments the discomfort of the honest number.
None of this changes what you owe. But it’s worth knowing, next time you look at a payslip, that the two deductions taking a bite out of the same pound aren’t really two different things at all. They’re one thing in two hats, and one of the hats exists mainly so you don’t quite notice the size of the other.
We help people in Hook and across Hampshire, Surrey, Berkshire, Sussex and Kent understand what they’re actually paying, and why, which is more than half the battle with a system built to be a little hard to follow.
Altor Wealth Management LLP is authorised and regulated by the Financial Conduct Authority (FCA number 769033). Registered office: Landmark House, Station Road, Hook, Hampshire RG27 9HA. This article is general information, not personal advice. Tax treatment depends on individual circumstances and is based on current legislation, which can change.