Calculating National Insurance accurately for company directors can become complex. Directors must pay National Insurance contributions like all employees. However, their salaries can be irregular. Bonuses and other factors make it harder to submit accurate National Insurance for directors. This article provides guidance on calculating National Insurance for company directors and offers tips on avoiding common pitfalls experienced by payroll teams.
Standard Earnings Vs the Alternative Method of NI Calculation
HMRC provides two main ways to calculate National Insurance for company directors. Standard annual earnings and the alternative method both provide an annual contribution total for directors’ salaries, and the decision on which to choose rests on how the director is paid. The key to accurate calculation is to ensure that there is consistency in how NI is calculated across the tax year.
Calculating Director’s NI using the Standard Annual Earnings Method
The standard method is commonly chosen for situations where directors are paid irregularly. Payroll teams calculate NI contributions against total pay over the tax year to date, including bonuses. NI thresholds are applied cumulatively from the start of the tax year, and the amount of NI paid already is then taken from the calculated contribution total.
The Standard Annual Earnings Method and NI
Directors will only start paying National Insurance when they reach their yearly threshold of £12,570, as their entire earnings for the year are checked each month, which means they may not pay NI until several months into the year.
If a director, with a National Insurance code A, has an annual salary of £30,000, earning £2,500 a month, they will not make an NI contribution until month six, when their annual earnings exceed the threshold of £12,570. In month six, they will pay £194.40, and from month seven onwards, they will regularly pay £200 per month in National Insurance. This means that the director won’t be hit with a large NI bill at the end of the tax year.
Calculating Director’s NI using the Alternative Method
The alternative method calculates the payment of a director’s National Insurance only on the pay they receive in that pay period. A benefit of the alternative method is the ease with which it can be run through payroll software, as the calculation can be applied immediately. However, the calculation only looks at one period at a time, with a recalculation of NI contribution at the end of the tax year to ensure that NI paid matches the National Insurance owed on the director’s total gross pay. This can result in a large NI bill for directors, as the alternative method doesn’t account for peaks or irregular payments through the tax year in the same way as the standard annual earnings method.
Payroll and HR teams will need to assess the regularity and uniformity of payments to directors before deciding the method that will provide the right balance of ease of calculation and payment vs accuracy of NI contributions.
The Method and NI, as an example provided by HMRC
A director is paid a monthly gross salary of £13,920 across 12 monthly payments of £1,160.
In months one and two, the director’s NIC contribution is £8.96 per month and the employer’s National Insurance contribution is £111.45 per month.
In month three, the director is paid a bonus of £10,000, bringing month three’s earnings to £11,160. The director receives their normal monthly salary for the remainder of the year.
By month 11, the total earnings are £22,760, £480.30 in National Insurance. Using the alternative method, NI is recalculated based on the total earnings of the directorship over 12 months (£23,920), meaning the director has accrued £908 in National Insurance contributions. Therefore, they must pay the difference between the amount paid and the amount owed, which comes to £427.70.
Using the alternative method, payroll teams can easily manage National Insurance contributions for directors who are paid regularly without large irregular payments during the tax year. This method is more suited for payroll software, but be aware of the potential for large end-of-year NI bills for directors who receive irregular payments through the tax year.
MSP Payroll can support your team with NI calculations for your executive team, directors and employees – click here to contact us to find out how.
How to apply NI thresholds and Rates to Director’s NI
Most directors will have the category letter A for National Insurance contributions, which means that they will pay 8% after exceeding £1,048.01 per month and then a further 2% once they exceed £4,189 per month. However, there are a number of other circumstances where thresholds may be different for directors, and payroll teams must be aware of the difference in the percentage applied to monthly salaries.
Payroll teams must also consider the impact of salary sacrifice and pension contributions, which are deducted from the gross salary and will therefore reduce the monthly earnings against NI thresholds.
Many payroll software platforms will provision differences in NI categories and gross salary levels; however, if there is a mistake, the Payroll team must find and fix it.
Working with a professional Payroll Service Provider like MSP Payroll can help mitigate issues with national insurance and directors’ salaries. Click here to speak to us and find out more.
Other Categories and Their Impact on NI Calculations
- B category
- Married women and widows with a certificate of election form
- 85% above £1,048.01 and an additional 2% from £4,189 and upwards
- C category
- Employees over the state pension age
- National Insurance is not applied
- H category
- Apprentices under the age of 25
- 8% above £1,048.01 and an additional 2% from £4,189 and upwards
- J category
- Employees who can defer NI because it has been paid in another job
- 2% above £1,048.01 and an additional 2% from £4,189 and upwards
- M category
- Employees who are under the age of 21
- 8% above £1,048.01 and an additional 2% from £4,189 and upwards
- V category
- Veterans in their first role since leaving military service
- 8% above £1,048.01 and an additional 2% from £4,189 and upwards
- Z category
- Employees under the age of 21 who are already paying NI in another role
- 2% above £1,048.01 and an additional 2% from £4,189 and upwards
Ensure that the director has the correct letter assigned for their NI by HMRC, and once that is confirmed, then calculate monthly and annual contributions based on the percentage above.
Freeports and National Insurance
Freeports are areas of the UK designated by the government for investment and economic development. HMRC has implemented National Insurance break incentives to allow businesses to focus cash on growth rather than tax or NI. An employer calculating NI for an employee working for at least 60% of their time in a Freeport zone, within the first three years of their employment, can pay 0% NI on up to £25,000 per annum of that employee’s salary. The employee must still pay NI as per their salary and category letter calculation.
Director Bonuses and Other Considerations
Director bonuses are commonplace, and they can create complications when trying to accurately calculate national insurance contributions. Payroll teams need to assess whether the frequency or value of bonuses will lift the director’s salary into the upper earnings threshold, or whether, over the year, this will be offset by lower salaries. Understanding the impact could make the difference between paying an per month in NI contributions and potentially receiving a large NI bill at the end of the year, or not.
For example, if the bonus is paid once, early in the tax year and over the course of a year’s earnings, it won’t push the director into the upper threshold, then calculating based on standard annual earnings would be preferable. If the bonus is part of a monthly incentive package for performance or sales, and the salary will exceed the upper earnings threshold, then there will be little difference between standard annual earnings and alternative method calculations.
If the director is new to the business or the role, also consider the tax responsibilities up to that point in the tax year, as this will also have an impact on choosing the right calculation method.
If your teams require more information on choosing an NI calculation method, then speak to us and we would be happy to advise.
Common Mistakes when Calculating Director’s National Insurance
Switching NI Calculation Method Mid Tax Year
It is possible to switch NI calculation methods during the tax year, as long as your payroll software is capable. Issues from switching calculations arise when payroll software or calculators are unable to assess the difference between the two calculation methods and the impact that has on NI contributions. Ideally, the software should calculate the best approach for the employee within the regulations of NI contributions, but if this is miscalculated, it could prove costly for the director.
Incorrect employee classifications
A frequent reason for incorrect NI contributions, incorrect director NI classifications often occur because the director isn’t aware of the different categories, or has just moved from one category to another and hasn’t informed the Payroll team. Regularly reviewing the director’s payroll information (in line with whole organisational reviews) will mitigate this risk.
Not adjusting NI calculations based on gross pay contributions
If a director is taking advantage of a salary sacrifice scheme, such as a car or technology purchase, this needs to be deducted from their gross salary before calculating National Insurance. If the purchase is significant, such as a car, this can mean a director stays below the upper earnings threshold and avoids the higher rate of 2%.
MSP Payroll can help your team mitigate these risks. Speak to us here to find out more.
Calculating Director’s National Insurance – Summary
Calculating a director’s National Insurance requires a strong understanding of the Payroll events throughout the year and which method will provide the most beneficial outcome for the organisation and the director. The standard annual earnings method evens out the spikes in irregular pay over the year and is the right choice when it isn’t certain the director will exceed the upper earnings threshold. The alternative method allows a Payroll team to incorporate their director’s NI contributions into their normal employee payment processes, but won’t account for large bonuses, particularly early in the tax year.
Implementing a robust payroll process with regular reviews and training will help mitigate the risk of mistakes, while consulting a Payroll specialist, such as MSP Payroll, can help inject extra resource and expertise into the organisation to ensure compliance. Speak to us if you would like to find out more.
How can MSP Payroll support your business?
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Our services cover:
- Ongoing payroll services such as director tax and NI calculations
- Service and support for specific payroll issues or challenges
- Correct deductions from statutory payments such as tax, NIC, pensions, etc.
- Ad hoc payroll on-demand, including daily administration
- Pension advice and payroll compliance
We provide seamless Payroll services for your organisation, increasing employee satisfaction while reducing the impact on internal resources and the cost of inaccuracies.
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