For those seeking autonomy and work-life balance, contracting can be a viable career path. However, freelancing comes with its own set of challenges such as financial management and compliance with tax and invoicing protocols. As your enterprise expands, your financial and administrative obligations will increase. It's at this point that you'll need to weigh the options and decide whether to opt for a limited company structure or partner with an umbrella company.
Whether you love or loathe umbrella companies, they're a fixture in the employment supply chain. While some contractors may go out of their way to avoid them, many appreciate the simplicity they provide. Most contractors have come to accept that partnering with an umbrella company is necessary to ensure they can meet their financial obligations.
How Do Umbrella Companies Work?
As a contractor, you still have the freedom to choose which projects to work on, while the umbrella company takes care of your employment administration. When you're contracted for a project, the umbrella company sends an invoice to the client and collects payment on your behalf.
You're enrolled in the umbrella company's PAYE system, and they pay you an income from the invoice after deducting taxes, National Insurance contributions, and agreed-upon fees. The umbrella company will also deduct any applicable expenses, which typically need to be pre-approved by the client.
Despite being a contractor, HMRC considers you a permanent UK employee when you work under an umbrella company. As a result, you'll be issued a tax code and pay a basic, higher, or additional rate based on your income, much like you would as a full-time or part-time employee.
Your take-home pay is determined by your tax rate and the fee charged by the umbrella company, which comes in two forms: a fixed fee or a percentage fee. A flat fee is charged weekly or monthly, usually around £100 a month, while a percentage fee is typically around 5% of your income, which can impact higher earners more significantly.
Advantages Of Contracting In An Umbrella Company
Signing up with an umbrella company is a stress-free process that can be completed in just over 10 minutes. You'll need to provide personal information, such as your date of birth, address, National Insurance number, assignment details, which is a legal requirement, and a proof of your identity and right to work in the UK.
-
No Tax Processes to Think About
By selecting a tax-compliant umbrella company, you ensure that your income is paid according to UK tax law and HMRC regulations. The company handles your income tax payments, so you don't have to worry about setting aside cash for tax bills and filing a tax return, avoiding the risk of missing payments and penalties from HMRC. Before the IR35 off-payroll changes of 2017/2021 and the rise of 'forced' umbrella working, many contractors outside IR35 opted for umbrella companies for this reason.
By joining an umbrella company, you become an employee and gain access to a range of valuable benefits that contractors typically miss out on. Despite the term "zero-rights employment" being thrown around, umbrella employees actually have a number of important rights, including protection against workplace discrimination, equal access to facilities, and access to employment tribunals in case of disputes.
After 12 weeks of employment, umbrella employees are entitled to additional benefits, such as equal access to pay, holiday pay above the minimum, sick leave, and parental time off. Some umbrella companies even offer extra perks such as health insurance, access to welfare services, and other benefits packages.
When working with an umbrella company, you have the freedom to take on various clients as you see fit, but you still benefit from the Continuity of Employment that comes with having a single employer. This is a major selling point for contractors seeking financial stability and long-term career growth. With the right support and guidance, umbrella employees can enjoy the best of both worlds—flexibility and continuity.
Disadvantages Of Contracting In An Umbrella Company
If you're looking to maximize your take-home pay, working under an umbrella company may not be the best option for you. Although the fees charged by most companies are relatively small, they can still add up over time, particularly for contractors with lower salaries.
Any benefits, such as holiday pay or employer pension contributions, are deducted from your contract day rate. Even employment costs like Employer's National Insurance and the cost of keeping recruiters happy are factored into your day rate. This can make it challenging to achieve financial stability in the long term.
Umbrella company pay slips can be very convoluted and ambiguous. It's not uncommon to come across concealed deductions or perplexing entries that just don't add up, resulting in umbrella companies potentially siphoning off money from their employees and facing current CJRS issues. This leak can range from a couple of pounds to tens of pounds per week, and it's a problem that plagues companies of all sizes.
When you entrust your finances to an umbrella company, you relinquish control over them as they take care of making all the necessary deductions and pay you the remaining amount. While this is a hassle-free and straightforward process, many contractors prefer a more hands-on approach when it comes to their finances.
It's an open secret that most umbrella company employees end up retaining only 60% to 70% of their pay, while contractors under a limited company structure (outside IR35) can enjoy greater retention. The PAYE system, traditionally reserved for permanent employees, is not a viable option for contractors due to the taxes and National Insurance Contributions involved.
Directors of limited companies can access tax advantages that are unavailable to umbrella company workers, but some may consider foregoing these benefits in exchange for the freedom from administrative responsibilities.
If you’re still deciding whether you contract via an umbrella company or not, consult with Legend Financial. We know what works best for you given our hands-on knowledge and experience on IR35 protocols.