With thresholds frozen, contractors need an 18% uplift, so a 4% NIC cut doesn’t cut it

The announcement that was rumoured and ended up as the headline of Spring Budget 2024 was a cut to National Insurance.

But, writes Dan Mepham, managing director of SG Accounting, was this a win for contractors, and taxpayers at large?

Spring Budget refresher: 2p off National Insurance

For the unfamiliar -- chancellor Jeremy Hunt at his March 6th statement announced a further cut to NI for employees, saying it would fall from 10%, to 8% from April 6th 2024. Combined with his previous 2% NI cut which was introduced on January 6th 2024, that delivers a total NI drop of 4% to employees since the start of the calendar year.

So, the government is choosing to enact tax breaks where taxpayers can potentially save up to £1,500 in just this calendar year alone. Surely that’s good news?

Well, yes, and no. Let’s look at the numbers in more detail, to understand why.

How much the NICs cuts mean for your pocket

The following table shows the Employee NI changes across the calendar year to date, and the NI payable to HMRC under each change depending on yearly earnings.

And the ‘winners’ are…

For individuals earning £50,000 a year via salaried income, they will see net savings of £62 a month in 2024/25 thanks to the Spring Budget NI changes (i.e. excluding the 2% cut of Jan 6th). Without doubt, these ‘£50k individuals’ are the biggest ‘winners’ from the NICs change.

Now, for a large majority of contractors and small business owners who utilise a tax-efficient salary and dividend split via their limited company, the change will not have any impact. Even with these downgrades in NI, contractors looking to adopt a higher salary to benefit from the reduced NI rate will still not be better off versus the dividend model they have now.

The three-pronged PSC squeeze

If anything, limited company contractors are likely to feel the pinch more by:

• the decrease in the dividend allowance (from £1,000 in 2023/24 to £500 from 2024/25);
• the reduction in the capital gains tax allowance (from £6,000 in 2023/24 to £3,000 in 2024/25), and;
• the freeze in personal allowances.

How about umbrella company employees?

For contractors who find themselves with an inside IR35 determination or are positioned to accept a role via an umbrella company, the changes will mean a higher net income for 2024/25, compared with 2023/24. That being said, with no changes to Employer NI thresholds, umbrella contractors still shoulder a large burden in comparison to an outside IR35 role via a limited company.

The freeze on the Employer NI threshold and income tax bands means they continue to be hurt by inflation.

This is what economists call “Fiscal Drag.”

Fiscal drag – what it means for contractors like you

Due to the government freezing the personal tax thresholds, for individuals whose income increases, in effect a higher proportion of tax is being paid.

With the freeze in personal allowance and the higher rate tax band staying at £12,570 and £50,270, respectively, and with inflation each year, it really feels that our money isn’t going as far as it once did.

With increasing costs, year-on-year, contractors are feeling the squeeze when it comes to withdrawing funds up to the higher rate threshold -- it’s no longer as sustainable as it once was. This, coupled with corporation tax changes, means contractors are feeling stung either way. 

In reality, what would the thresholds need to be to combat inflation?

In light of this, according to the Bank of England inflation calculator, the government would need to increase the tax thresholds as follows – if it wanted to combat an increase in costs since 2021 which was when the freeze came into effect.

• Personal allowance would need to increase from £12,570 to £14,903 a year.
• Basic rate band would need to increase from £37,700 to £44,697 a year.

The uplift in both thresholds required to be on par with inflation since 2021 -- a hefty 18% -- is only set to get bigger, because the current government plans on keeping both of these frozen until 2027/28.

So 18 per cent, as swingeing as it is, is only the start of how much fiscal drag is taking from your take-home.

What can contractors do about this 18% take-home dent?

Our contractor accountancy practice is advising our clients to focus on their specific circumstances to maximise their income and tax efficiencies. It’s unfortunately remarkable how many contractors still fail to keep receipts, claim for trivial benefits, staff entertaining and pension contributions.

Speaking to regulated financial advisers is also recommended to see where the Enterprise Investment Scheme and Venture Capital Trust scheme might be able to tap into further investment savings, with a view to mitigating the higher rate tax charges.

Overall though, the NI tax reductions of 2024 acts as smoke and mirrors for what the actual headline is; that personal tax thresholds remain unchanged. Unless you're a contractor employed via an umbrella with an equivalent salary of £50,000, the NI drop really leaves nothing to be desired.