What do NI cuts mean for the state pension?

The second cut to National Insurance in six months, and growing rumours of the tax’s eventual abolishment, have raised questions about what this means for the state pension.

On 6 February, chancellor Jeremy Hunt announced a 2p cut to National Insurance (NI) contributions for both employees and the self-employed. This was the second cut to NI in under six months and added to the rumours the government is considering abolishing the tax altogether.

The largest benefit paid from the UK’s National Insurance Fund is the state pension. Out of the £115.7 billion in benefits paid from the fund in 2023, £110.2 billion of this was made through state pension payments. Given NI contributions are the largest source of income to the fund, accounting for £129.1 billion of the £133.1 billion paid into the pot during 2023, questions are naturally being raised about what cuts to this tax could mean for the state pension.

However, experts point out this issue is less straightforward than simply being about funding levels.

Gregg McClymont, executive director of public affairs at IFM Investors and a former pensions spokesperson for the Labour party, said: “The question here is about whether taxes in the UK are actually hypothecated – i.e. does NI in reality pay pensions as opposed to contributing to overall government revenue from which state pension is paid. I would say it’s the latter.”

In reality, the relevance of NI to the state pension is less direct than when the concept of the former was established just after the Second World War. The fund is not ring-fenced and the government are not restricted to only top it up with NI contributions.

“Basically, NI is a work of fiction really, and essentially another tax,” said Steve Webb, partner at LCP and former pensions minister. “Essentially if the NI fund runs low on money, they just top it up with other tax revenues and this was done in the 1980s when we had such high unemployment.”

A matter of entitlement
Instead, NI contributions have a greater say in who gets state pension benefits. Taxpayers must have over 35 years’ NI contributions to get a full state pension but there is little nuance in the relationship between contributions and benefits.

Tom McPhail, director of public affairs at the lang cat, described the link as “already somewhat tenuous”. He explained: “If you pay NI for less than 10 years you get nothing and even if you have paid for 35 years and built the maximum entitlement to a state pension, your NI payments don’t then drop to reflect the fact you’re not getting anything more for your money.”

There is a credit system in place for some cases that allow UK citizens to access a state pension without paying NI contributions. This exists for parents with young children, who are awarded a year towards their state pension even if they don’t pay NI, and a “lower earnings limit” for some workers who qualify.

If NI was to be completely abolished, and given the state pension can be paid with any government revenues, this would instead pose questions about entitlement.

“It’s messy but it’s far from unprecedented,” said Webb. “These things are never as simple as they look but, because we have the concept of crediting, it’s not as much as a leap of what it might have been without.”

McPhail is in agreement, pointing out that NI and the state pension could be “entirely divorced” if an appropriate entitlement framework was introduced.

“We could have a “citizen’s pension” based on length of residence in the UK for example,” suggested McPhail. “The important thing however is to make sure it’s defined, clear, fair, transparent and sustainable.”

To abolish or not
When making his 2024 Budget speech, the chancellor called it his “responsible budget”. While the 2p cut to NI would account for an estimated £10 billion reduction in revenues, according to Budget documents, new rules were announced to target non-doms, owners of second homes and business travel flyers. The politics of these announcements, in a year of a general election, are clear and Webb pointed out the sense in cutting NI.

“The reason they chose NI rather than income tax is they wanted to spend as much of the money as possible on people who aren’t pensioners, because pensioners pay income tax but not NI,” said former pensions minister Webb. “It’s really about putting money in the pockets of the people they were most targeting.”

NI may provide an easy target for a government due to the go to the polls, but anything more sizeable than a percentage trim is unlikely to come soon. This isn’t just due to the timing challenges an election year poses, but the complexity that would need to be circumvented to ensure state pension entitlement is fair and works.

McPhail explained: “I’m broadly in favour of merging NI and income tax into one system, however it’s very complicated and there’s not much political credit to be gained from doing it. From an accounting point of view, it would require some rerouting of the internal plumbing between the Treasury and the Department for Work and Pensions but in the end, it is all just one pot of public money.”