Why should I pay national insurance once I've paid enough for a state pension?

After a reader got in touch with this question, we asked former pensions minister Steve Webb to help explain.

I am often asked why people should have to go on paying national insurance contributions (NICs) if they have already built up a full pension or have gone beyond the 35 years they have heard is needed for a full pension. To understand why, it is worth going back to the basics of how the NI system works.

Unlike when you put money into a private pension, your NICs are not set aside in a ringfenced pot to be spent on your state pension when you retire. Instead, the NICs of today’s workers are used to pay the pensions of today’s pensioners.  

In some ways, therefore, NICs are a bit like other taxes. Whether or not you have personally built up entitlement to a full state pension, the Government still needs money this year to pay this year’s pensions. If people could stop contributing once they had earned a full pension of their own, this would leave a shortfall, which would have to be met through higher taxes or NI contributions somewhere.

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Also bear in mind that the state pension system seeks to protect those who, through no fault of their own, are unable to pay their own NI contributions. This money has to come from somewhere. For example, if someone is at home bringing up a young child or caring for an elderly relative, they may not be able to undertake paid work and therefore not pay NI contributions. But as a society, we have decided these caring responsibilities are of value and should not be penalised when people come to retire. As a result, carers often receive ‘NI credits’ towards their eventual state pension. 

These credited pensions have to be paid for, and one way in which this is done is by continuing to levy NI contributions on people who are still working despite having already built up a full pension.  

Another misconception is that paying 35 years of NICs is enough to guarantee you a full state pension. Unfortunately, things are not quite as simple. This is because in the past there were two main rates of NI contributions (plus a special rate for some married women) and those who paid the lower rate may not get a full state pension even if they contribute for 35 years. 

Prior to 2016, the NICs rate you paid depended on whether or not you were a member of an occupational pension scheme through a process known as ‘contracting out’. A deal was done between the pension scheme/employer and the Government, under which the scheme promised to replace part of the worker’s state pension. In return, the employer and employee were both allowed to pay NICs at a lower ‘contracted out’ rate.

At retirement, a deduction would be made from the state pensions of those who had been contracted out, reflecting the fact they had paid in at a lower rate. Under the new state pension – introduced in 2016 – a one-off deduction is made from the state pension rights of those workers who have been contracted out in the past. Because of this deduction, even those who have 35 years in the system by 2016 may not have accrued a full state pension at that point if they were previously contracted out.

The good news for those in this position is that each year they contribute from 2016 onwards will build on their state pension until it reaches the new flat-rate amount, currently £185.15 per week*. 

Once the new state pension system is fully bedded in, much of this complexity will drop away. Those with 35 years will simply get the full flat-rate pension and anything beyond this will simply help with the general cost of providing pensions to today’s retired population. But in this transitional period between the old and new scheme, paying extra contributions beyond 35 years may in some cases help to boost their pension. Even if it does not, those contributions will be helping to make sure today’s retired population get the pensions they have earned.

Steve Webb was formerly Minister for Pensions, then Director of Policy at Royal London. He left Royal London in 2020 to become a partner at consultancy Lane Clark and Peacock.

Article, written while Mr Webb was at Royal London, was amended in February 2023 to change flat-rate state pension figure from £168.60 per week to £185.15.

*From April 2023, the full new state pension will rise from £185.15 to £203.85 a week.