Going self-employed is a big step in your career. And it could be something you look back on fondly. It gives you more flexibility, a better work-life balance and typically a higher rate of pay. But it isn’t without its complexities and hurdles, including where to start. That alone is something that puts a lot of people off.

Before you register with HMRC as self-employed, there are two main routes of getting paid for your work that you need to consider – working through an umbrella company or forming your own limited company. These routes will determine how your journey into self-employment works – from your statutory rights to the way you pay tax & even your self-employed status itself.

So which is best? Unfortunately, it’s not that simple, as this guide from Umbrella Broker will explore. Both routes have advantages, drawbacks and important things to consider. Read on as we take a look at limited companies versus umbrella companies when it comes to your self-employment options.

Limited companies

What do you want from self-employment?

In many cases, the answer is independence, control and increased earnings. Limited companies deliver exactly that. They allow you to make the most of your earnings with a more tax-efficient set-up.

With a limited company, rather than putting 100% of your income through pay-as-you-earn (PAYE) tax calculations like you would as an employee, you can combine expenses deductions low tax dividend payments to lower your salary (and therefore the amount you put through PAYE). Essentially, this means more money going into your pocket rather than straight to HMRC.

Limited companies also give you more power over how you work. Because you’re literally your own boss – the boss of your limited company – you can market your services however you choose and take on whichever contracts you wish.

The downside

The downside is that limited companies require more work. Setting up and running a limited company is by no means easy. For one, because of tax. While limited companies are tax-efficient, they need to be completely tax-compliant and adhere to financial regulations. When taking out dividends, for instance, the business still needs to be generating a profit while you’ll need to compose and file accounts annually.

Couple regulations with the hassle of organising your own invoicing, chasing bad debts, managing all your payments, processing payroll (calculating tax) and registering as self-employed in order to fill out an annual self-assessment. There is also the extra administration burden that comes with managing a limited company to consider.

To help ease the burden of running your own company, it’s best to partner with an accountant who’s used to working with contractors. Your accountant will complete both your annual accounts and self-assessment forms while some will even provide you with free access to online book keeping software to track expenses and invoice clients.

Once you have a limited company and have registered with HMRC as self-employed, you’ll need to tie up some loose ends in order to be able to contract such as sourcing your own employers liability insurance, professional indemnity insurance and professional liability insurance. There are specialist providers of contractor insurance available such as Kingsbridge who can make finding an insurance policy quick and easy, however the price of your insurance will depend on your industry, role and day rate.

How to set up a limited company

Due to their tax advantages, a limited company is often the preferred route for contractors. To set one up, you firstly need to choose a name. This should reflect what you do as a business – rather than simply being arbitrary. It also needs to adhere to the rules set out by Companies House, including:

  • Not the same as, or too similar to, an existing company name – unless you have permission from, or a connection to, that company
  • Names cannot be offensive or contain any sensitive words without permission
  • The name must end in Limited or Ltd

Before registering a company name, it’s also worth considering your website. If you’re looking to create a website, now or in the future, you’ll want the domain name to match your business. Try to find a business name that is available as a domain.

Following this, your company needs to be incorporated. Incorporation is essentially just a case of filling out forms – either in paper or online – through Companies House. It costs £10-12 online or upwards of £40 for paper documents. Once your company is registered, it’s time to sort out insurance and a business bank account. 

Umbrella companies

Umbrella companies are the hassle-free alternative to working as a limited company. Essentially, they provide the freedom of working as a contractor with the ease of working as an employee.

Working through an umbrella company means you don’t have to take on all the administrative work that’s involved with running your own company – not to mention setting it up and you don’t need to register as self-employed.

When you sign up to an umbrella company, you will be classed as an employee of the umbrella. Unlike a conventional employer, however, they won’t tell you what to do, when to do it or even how to do it. In essence you’ll act as self-employed, but be employed for the purposes of tax.

You will be able to take on contracts with your clients as normal, but your umbrella will engage with them on your behalf. Instead of invoicing clients yourself or paying an accountant to do so, you fill out a timesheet and the umbrella company will invoice the client for your work. Your umbrella company will then chase the debt and once the funds are received, run a payroll for you and deduct the right amount of tax. You’ll even get a pay slip.

As an added benefit, by working through an umbrella you’ll also get all the perks usually enjoyed by employees such as holiday pay, sick pay and insurance. In particular, having professional liability and professional indemnity insurances provided by the umbrella will save you the hassle of having to source and pay for your own.

The downside

The downside of using an umbrella company is that you typically pay more tax than you would through your own limited company. On top of that, you’ll have to pay a fee to the umbrella company itself meaning you could take home less than an employee would on the same day rate.

Despite this, you will usually still take home more than you did as a permanent employee – even in the early stages of contracting because clients pay contractors more per day than they would an employee.

Finding the right umbrella company

Unlike setting up a limited company, getting started with an umbrella company is very simple. The only challenge is finding the right umbrella company for you. Umbrella companies vary in a range of ways, so it’s important to make the right choice before signing any contracts.

Every umbrella company will tax you at the same PAYE rate, but they don’t take the same amount as a fee. While it may be tempting to choose the umbrella company with the cheapest service fee, they might also offer different benefits with some benefits having an equivalent cash value that’s higher than the increased fees they are charging. In effect, to calculate your net take home, you need to look at both the after tax amount you receive and the cash equivalent of the benefits on offer.

It’s important then to compare umbrella companies and find out what pension scheme, sick pay, statutory leave and benefits are available – as this could make higher fees worth the cost.

Umbrella companies also differ in their payment structures. Some will pay you as and when they receive payment from your clients. On the other hand, some umbrella companies will collect all of your earnings and pay you on the same date each month – more like a standard employer. Which is better? It’s up to you. The monthly payment might make it easier to manage your finances. However, it could just be frustrating for some contractors.