Contracting is an exciting career change for professionals in all kinds of sectors. It provides more income, added freedom and extra flexibility in the way you work. Rather than providing your services to an employer, you sell them directly to a client who pays you much like another company.

However, unlike another company, you don’t have to use the same invoicing and payment route. Contractors can choose between setting up a limited company and working through an umbrella company. Unlike the sometimes-overwhelming step of setting up a limited company, an umbrella company provides a simple and straightforward way to start your contracting career.

Want to know more? Read on as Umbrella Broker looks at how umbrella companies work, how they compare to the alternatives and whether a contractor umbrella company is right for you.

The basics of umbrella companies

It’s understandable that some people are unfamiliar with umbrella companies. If you’re not a contractor, they’re not really something you will encounter. However, they’re actually one of the most common options for contractors because of how easy they make it to work for yourself.

While limited companies need to be set up and run by contractors, umbrella companies simply hire contractors as pay-as-you-earn (PAYE) employees. You are added to the payroll of the umbrella company and pay a fee to them. For this fee, they take care of all your administrative and financial duties – like a permanent employer.

They will provide statutory rights like insurance and paid leave. They’re also responsible for paying your taxes, so any money you receive is your take home pay. However, unlike a permanent employer, your umbrella company won’t set you work. You can take on contracts as normal, focus on work and leave the administrative work to them.

How do umbrella companies work?

When you’re employed by an umbrella company, you simply submit your timesheet to them after each contract. They will then invoice your client and chase payments, like a middle man working on your behalf. Once payment is received, the umbrella company will deduct and pay the right amount of tax and national insurance contributions (NICs) from your wage and transfer you the final sum.

Should I use an umbrella company?

Umbrella companies aren’t for everyone. The alternative – setting up your own limited company – provides higher income as a trade-off for more administrative work. With that in mind, umbrella companies are the ideal solution for contractors that don’t have the time to run their own business while also completing contract work.

Unlike a limited company, there’s no need to keep track of different payments, create and send invoices or calculate your own tax and NICs. It also removes the burden of company accounts and VAT returns, so you have complete peace of mind and can focus on the job at hand for each contract you work on.

You don’t have to kick back and relax though. The time and energy you save can be put towards more work or other projects. You could even spend the time on training to improve your skills and secure higher-paid contracts in future.

Umbrella companies are also useful for people who are new to contracting. Many professionals use them as a transition between regular employment and running their own business. As you become more experienced and establish a bigger client network, it’s possible to switch to a limited company at a later date.

It’s also the ideal route if you only plan to work in contracting for a temporary period as it’s easy to move in and out of an umbrella company – as opposed to setting up and dissolving a limited company. For that reason, many professionals use umbrella companies to try out contracting and see if it suits them.

Umbrella company vs limited company

Setting up a limited company, as mentioned, is the main alternative to working through an umbrella company. It’s the route that matches “be your own boss” to a tee. And it has significant financial benefits if you’re willing to put in the extra work.

Limited companies are a more tax efficient option. Contractors name themselves as the company director and sole shareholder, taking a salary as dividends. There are other tax benefits too, with directors entitled to claim back tax on accountancy fees or office costs in some cases.

Another benefit with limited companies is the removal of a service fee. As you’re running your own company and taking care of your own finances, there’s no need to pay a service fee from your income.

However, with this role comes extra responsibility. Unlike an umbrella company, you’re solely responsible for your finances, tax and general administration. That means processing invoices, chasing payments and paying yourself through the company. It may even be worth hiring an accountant to assist with these responsibilities, which could take away some of the financial benefit.

Making your choice

To decide between an umbrella company and limited company, carefully consider how much time and effort you can commit to contracting. If you’re just starting out or, for whatever reason, you don’t have the time to take care of invoicing and tax, an umbrella company may be the best option.

Alternatively, if you’re looking for the highest possible income and you’re prepared to commit the time and effort – a limited company might be suitable. Remember, a limited company is more of a commitment, while you can easily use an umbrella company for a short period to test things out.