PAYE vs Umbrella: What’s the most cost effective option?

PAYE vs. Umbrella

What is PAYE?

 Let’s start by looking at exactly what PAYE means. PAYE, or pay-as-you-earn is the most common form of income tax in the UK.

With this system, tax and national insurance contributions are taken from the contractor’s salary before it is paid to them.

Most payroll workers are taxed through the PAYE system. The exception lies with the self-employed who work off-payroll. These workers instead fill out a tax return, under which a self-employed individual or business pays their tax annually, quarterly or monthly after they have processed their income and outgoings.

Contractors that opt for the PAYE option will be taxed in line with current tax bands and will work through a PAYE agency who will source and secure contracts for them to work on.

PAYE tax bands in 2020

Although tax bands can change from year to year, current tax bands in the UK for 2020 – 2021 are as follows:

England 

 

  • Tax free Personal allowance: up to £12,500 per year
  • Basic rate (20%): £12,501 - £37,500 per year
  • Higher rate (40%): £37,501 - £150,000 per year
  • Additional rate (45%): over £150,000 per year

 

Scotland

 

  • Tax free Personal allowance: up to £12,500 per year
  • Starter rate (19%): £12,501 - £14,585 per year
  • Basic rate (20%): £14,586 – 25,158 per year
  • Intermediate rate (21%): £43,431 - £150,000 per year
  • Top rate (46%): over £150,000 per year

Wales 

 

  • Tax free Personal allowance: up to £12,500 per year
  • Basic rate (20%): £12,501 - £50,000 per year
  • Higher rate (40%): £50,001 - £150,000 per year
  • Additional rate (45%): over £150,000 per year

PAYE vs Umbrella 

When it comes to PAYE vs umbrella, it’s important to note that technically umbrella companies do not differ from PAYE.

Just as a PAYE agency does, an umbrella company hires the contractor as their employee, putting them on their payroll and processing their income and tax through the PAYE system.

So, what is the difference when it comes to PAYE vs umbrella?

The main difference between the two is who the contractor chooses to work with and how this will impact the way they contract.

A PAYE agency will employ the contractor, process their salary and tax through the PAYE system and choose which contracts the contractor works on and when. PAYE agencies are easy to join and entitle contractors to statutory benefits received by employees, such as holiday and sick pay.

However, the main drawbacks of the PAYE agency option are that contractors cannot choose which contracts they work on and when. For contractors looking for full control over their work, this usually means this isn’t the best option.

When it comes to an umbrella company, the contractor will again be employed by the company with their salary and tax will being processed through the PAYE system, they will also receive statutory benefits, however the main difference is that the contractor can choose which contracts they work on and when.

This is one of the biggest appeals to many contractors looking for the freedom and flexibility to choose the projects they work.

The third option: self-assessment

It is also worth considering that there is a third option for contractors. With the self-assessment route contractors will be self-employed, usually operating under a limited company.

With the option, the contractor will not be put onto a company or agencies’ payroll. They will instead carry out a self-assessment, responsible for making their own tax and National Insurance contributions once they have been paid their contractor fee.

With this option, the contractor will still be subject to the current tax bands, the only difference is how their tax is paid.

Although this option offers complete freedom for the contractor, the drawbacks are that the contractor will not receive statutory rights enjoyed by employees and will face the complexity of filing their self-assessment tax return and hassle of running a business.

PAYE vs Umbrella: which is the most cost effective? 

When it comes to deciding between PAYE vs umbrella, many contractors want to look for the most cost effective option. However, because both these options use the same tax rates, neither option is more cost efficient than the other. That’s why contractors should instead make their decision based on which option works best for them.

The decision will ultimately boil down to whether the contractor wants complete freedom in carrying out self-assessment and setting up their own business, or whether they want the stability and ease of working under an agency.

If a contractor does choose the agency route, the next step will be to decide between PAYE vs umbrella. This decision will come down to whether the contractor wants to choose which contracts they work on under an umbrella company, or whether they want this decision to be made for them, in which case a PAYE agency will be the better option.

Many contractors will choose the umbrella company route as a way to couple the security and stability of being employed with the benefits of being self-employed in being able to pick and choose what contracts they work on and when.

If an umbrella company sounds like the perfect path for you, the next step is to find the best umbrella company for your needs.

Find the best umbrella company with Umbrella Supermarket

Once you’ve decided between PAYE vs umbrella, contractors that have opted for the umbrella company route will now need to find the best umbrella company for their needs.

That’s where Umbrella Supermarket’s handy umbrella calculator comes into play. We make it quick and easy for contractors to find the best company based on their personal preferences. Simply enter your details and we will generate a list of the best suited umbrella companies for you.

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