Guide to PAYE vs. Umbrella

How to decide between PAYE and Umbrella

What is PAYE?

Let’s start by looking at the first option – PAYE.

PAYE refers to the pay-as-you-earn way of paying income tax. This is how most workers in the UK pay their tax contributions unless they are off-payroll workers such as the self-employed.

Anyone who pays their tax through the PAYE system will do so in line with the current UK tax bands:

  • Tax-free Personal allowance: up to £12,570 per year
  • Basic rate (20%):£12,571 – £37,700 per year
  • Higher rate (40%):£37,701 – £150,000 per year
  • Additional rate (45%):over £150,000 per year

It is worth noting that tax bands differ throughout the UK depending on whether you are based in England, Wales, Scotland or Ireland. You can check out the different tax bands in this government guide.

When a contractor refers to working PAYE, they are employed by a PAYE agency. This means they will be paid through the PAYE system.

What is an Umbrella company?

The other option is to choose an umbrella company.

With this option the contractor also becomes an employee of their chosen umbrella company and will pay tax through the PAYE system.

Although both PAYE and umbrella are similar in these ways, they differ in a variety of ways. Next, we will look at the differences between each, so contractors can take the right path for them.

PAYE vs Umbrella: What are the differences?

Statutory benefits

One key difference between PAYE and umbrella is the contractor’s entitlement to statutory rights including holiday pay, sick leave, a workplace pension and maternity or paternity leave.

Under an umbrella company, as the company’s employee, the contractor qualifies for statutory rights should they fall ill or want to take a holiday.

Just as it sounds, this is considered a massive benefit by thousands of umbrella contractors giving them a well-needed safety net.

However, with the PAYE agency option contractors don’t receive these statutory benefits.

This is a clear drawback of the PAYE agency route and means that if the contractor can’t work due to illness, or just wants to take some time off, they will not be paid for this time out of work.

How the contractor works

The next main difference between both options is how the contractor works and operates under each.

After all, with a PAYE agency contractors are told which contractors they will be working on and when. This means that contractors have no choice over the types of contracts they take on and which clients these contracts are with.

Some contractors see this a major drawback as it means they have less freedom and flexibility in their careers and can't go after better paying contracts if they wish to.

Umbrella company contractors, on the other hand, are free to make these decisions themselves. The ability to choose their own contract work gives umbrella company contractors more control over their contracting careers and means they can progress at a speed that’s right for them.

Expenses

Another difference between PAYE and umbrella is who can claim expenses.

It is usually the case that umbrella company contractors are able to claim business expenses back. As these costs are considered a legitimate business expense by HMRC, this is a big bonus for umbrella company contractors as they can be offset against their tax bill.

With PAYE, contractors can’t usually claim their expenses back, meaning these contractors don’t benefit from this tax relief.

Continuity of employment

The final key difference between PAYE and umbrella is continuity of employment.

Umbrella companies give contractors continuity of employment. This means that although the contractor might work on several different contracts in a year, this is considered as one run of employment meaning the contractor receives one handy tax code. This comes in useful for things like applying for a mortgage or getting out a loan.

On the other hand, PAYE agencies don’t provide contractors with continuity of employment. This can make things tricky and confusing and also hinders the contractor’s ability to borrow money.

The third option – self-assessment

When looking at PAYE vs umbrella, it’s important to consider that there is also a third optionself-assessment.

This is when the contractor works as a self-employed person meaning how they operate and pay tax will differ.

Although the tax bands are exactly the same whether you choose PAYE, umbrella or self-assessment, the main difference is how and when you pay this tax.

Whereas with the PAYE route contractors will pay tax owed before they get their salary paid through, with self-assessment tax is paid after the contractor receives their fee. This works in that the contractor is paid their fee by the client and then must then work out how much tax and National Insurance they owe.

Just as it sounds, self-assessment can often be tricky and time-intensive, meaning many of these contractors will end up paying for the services of an accountant.

For the reasons stated above, many contractors will opt for the umbrella company option. In fact, umbrella companies have become more and more popular over recent years. If you would like to join the thousands of umbrella company contractors, the next step is to choose an umbrella company for you.

Find an umbrella company with the help of Umbrella Supermarket

Simply head over to our umbrella company calculator, enter a couple of key details and we will show you a list of the best-suited umbrella companies for you.

We only ever work with the best, most reputable companies out there, so you know you’re choosing the right one for you. Ready to give it a go for yourself?

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