PAYE vs Umbrella: Guide for Contractors

PAYE vs Umbrella: Options for Contractors Explained

 

During the current COVID-19 pandemic, although many industries are facing hardships and difficulties, some sectors are experiencing growth and a strong demand for more, short-term workers and skill-sets. This is great news for contractors who are pros at short-term, skilled project work.

Whether you are a seasoned contractor or are now considering contracting as a way forward, every contractor wants to know what the best, most cost-effective route forward is – whether that’s working through PAYE or umbrella.

To help contractors carve the best path forward, Umbrella Supermarket explain exactly how the PAYE and umbrella routes differ and sum up the pros and cons of both to help every contractor choose the best, most cost and time effective contracting option for them.

Option 1 - PAYE

PAYE simply stands for pay-as-you-earn - referring to the standard form of income tax in the UK. Under the PAYE system, tax and National Insurance contributions are taken from a contractor’s salary before it is paid to them. You will likely be aware of this method of taxation as the most common in the UK, with most employees paying tax this way.

If contractors choose this route, the PAYE agency becomes responsible for finding and securing their work and paying their salary through the PAYE tax system.

The contractor will pay tax in line with current PAYE rates based on the following tax bands:

England and Northern Ireland:

 

  • 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

 

Option 2 - Umbrella Company  

When choosing between PAYE and Umbrella, many contractors understandably face confusion. After all, technically umbrella companies do not differ from PAYE. An umbrella company also acts as the contractor’s employer, putting the contractor on their payroll, processing their income and paying tax and National Insurance contributions on their behalf through the PAYE tax system.

So, what is the difference between PAYE and umbrella?

The main difference is that, unlike a PAYE agency who employs the contractor and finds their contract work for them, an umbrella company gives the contractor greater freedom to choose what contracts they work on and when.

The umbrella company still employs the contractor and pays their salary through the PAYE tax system, but they allow contractors more flexibility to decide what work they take on.

Option 3 – Limited Company

There is a third and final option – to operate under a limited company and pay tax and National Insurance contributions on a self-assessment basis.

Contractors that choose to set up and work under their own limited company will pay the same tax rates - their tax contributions are just paid differently. Unlike the PAYE system under which contractor’s tax contributions are deducted from their income as they earn, self-assessment contractors are paid a pre-tax amount and are then required to work out and pay their tax contributions for a specific time period – this can be monthly, quarterly or annually.

Which option is best for contractors? – PAYE vs Umbrella?

Now you have a clear picture of your options, you can choose the best route forward to suit your contracting needs. This means weighing up what best works for you.

When looking for the most cost effective option between PAYE and umbrella, it’s important to note that you will pay the same amount of tax whichever option you choose since your pay is processed through the PAYE system with both options. As neither option is more or less cost-effective, this shouldn’t impact a contractor’s decision.

What contractors should look at when it comes to PAYE vs umbrella, is how much freedom they want over choosing contracts to work on:

  • Limited company: this is usually the best option for contractors seeking complete control and freedom over their work as contractors have free reign to source, secure and deliver contracts. The drawback with this option, however, is that contractors will also be liable to work out and file their own tax contributions and be responsible for the paperwork that comes with running your own business. Finally, as limited company contractors are not employees, they are not entitled to statutory rights.
  • PAYE agency: perhaps the easiest option for contractors is operating under PAYE. After all, the agency will find and secure your contracts and pay your salary through PAYE. You will also receive benefits that every employee is entitled to, including holiday, sick and maternity/paternity leave.
  • Umbrella company: the final option is perhaps the best of both worlds. Working under an umbrella company gives contractors the freedom to choose which projects they work on, without having the responsibilities of running their own limited business – such as filing tax returns or business admin. The umbrella company processes the contractor’s salary through PAYE, whilst allowing the contractor the freedom to choose their own contracts.

Use our Umbrella Company Calculator to find the best fit for you

For contractors that choose the umbrella company route, it’s now time to find the best umbrella company for your needs. That’s where Umbrella Supermarket’s award winning Umbrella Company Comparison Tool comes in handy. Our tool lets you compare the best umbrella companies online in just 2 minutes. We don’t take your details and say we’ll call you back later, we give you real results instantly, letting you get on with finding the best umbrella company for you.

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