Summary:
Timeline treats self-employed income as gross
Self-employed income can be either inflation-adjusted (fully adjusted to CPI) with a 0% collar applied or not inflation-adjusted.
National insurance and income taxes are computed based on the latest rates (currently for the tax year 2024/2025).
Description
This article will explain our approach to modelling self-employed income, how we compute national insurance and income taxes, and provide an illustrative example.
Modelling Self-Employed Income
In Timeline, self-employed income is treated in gross terms. We offer flexibility by allowing the self-employed income to be either inflation-adjusted (fully adjusted to CPI) or not. If inflation adjustment is chosen, we apply a 0% collar, ensuring the income will never decrease during a deflationary period.
The national insurance and income taxes are computed based on the most current rates. As of the time of writing, the rates are up-to-date for the tax year 2024/2025.
Calculation of National Insurance and Income Tax
Step #1: National Insurance Contributions Tax
Timeline calculates the national insurance tax based on the annual income:
If the annual income is less than £12,570, the national insurance tax is £0.
For Class 4, if the annual income is between £12,570 and £50,270, any income above £12,570 and up to £50,270 is taxed at 6%. If the annual income exceeds £50,270, then £37,700 is taxed at 6% and any income exceeding £50,270 is taxed at 2%.
Step #2: Income Tax and Total Tax
Timeline computes the income tax based on the current rates and bands for the tax year 2024/2025.
The total tax is then calculated by adding the national insurance tax and the income tax. Finally, this total tax amount is subtracted from the self-employed income to derive the net income that the taxpayer will receive.
Example
Consider John, a self-employed individual who earns £100,000 a year. For Class 4, the first £37,700 over £12,570 is taxed at 6%, equating to £2,262, while the remaining £49,730 is taxed at 2%, amounting to approximately £995. Thus, John's total Class 4 tax is £3,257.
John's income tax for the year is calculated as £27,432. Adding this to his national insurance contribution yields a total tax of £30,689. Therefore, John's net annual income is £69,311 (£100,000 - £30,689).
Conclusion
In this real-life example, John's total tax liability for the year breaks down as follows:
Class 4 tax: £3,257
Income tax: £27,432
John's net self-employed income for the given year is £69,311. By accurately modelling national insurance and income taxes for self-employed income, Timeline Planning aids financial advisors in navigating the complexities of financial planning. We hope this article and its practical example have shed light on this critical aspect of our cashflow modeling tool.