Throughout their careers, contractors must make a range of decisions. From what rates they will charge, which clients they will work with to whether they will choose PAYE or umbrella.

PAYE vs umbrella is an important decision that will impact many aspects of a contractor’s day-to-day life, therefore, it isn’t a decision that should be rushed. Instead, it’s important for contractors to do their research, look at the pros and cons of each and weigh up their options.

To help, Umbrella Broker has put together this ultimate guide outlining the key differences between PAYE and umbrella, so every contractor can make the right choice.

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Option 1: PAYE (pay-as-you-earn)

First, let’s look at PAYE.

PAYE stands for pay-as-you-earn. This is the most common form of income tax in the UK and is how most payroll workers pay their tax.

With the PAYE system, a worker’s tax and National insurance contributions are taken from their salary before it is paid to them, based on how much they are earning.

As we’ve mentioned, most workers are taxed under the PAYE system, apart from those that work off-payroll. These workers or businesses will instead fill out a self-assessment tax return which is done annually, quarterly or monthly after their income and outgoings have been processed.

Payroll workers that are taxed through PAYE are subject to current 2020-2021 tax bands 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

When a contractor chooses to work under a PAYE agency, they will be employed by them and their tax and National Insurance will be processed under this system in line with these tax bands.

Option 2: Umbrella

The second option for contractors is to work under an umbrella company.

Just like with a PAYE agency, an umbrella company employs the contractor, pays them a salary and processes their tax through the PAYE system.

However, although both the PAYE and umbrella options process tax in the same way, there are several key differences between the two options.

Differences between PAYE and umbrella

One of the biggest differences between PAYE and umbrella is the way that contractors operate within each.

With an umbrella company, contractors are free to find their own contract work, choose which clients they work with and decide when they will take on work.

This is very appealing to many contractors, giving them the same degree of freedom and flexibility as a self-employed, limited company contractor, coupled with the security of being employed by the umbrella company. It also means they are free to pursue their own areas of interest and progress their career at their own pace.

On the other hand, however, with a PAYE agency, contractors cannot choose which contracts they work on. Instead, the agency will decide what work you take on and when.

Another main difference between the two options is continuity of employment.

Whereas an umbrella company offers contractors continuity of employment, meaning one handy tax code, a PAYE agency does not. This can make life a lot harder for contractors who are looking to take out a loan or a mortgage.

Finally, another key difference that may influence your decision is the ability to claim for expenses.

Whereas most umbrella companies allow contractors to claim back legitimate business expenses, typically PAYE agencies do not.

Expenses can usually be offset against your tax bill, meaning the ability to claim expenses is considered a big advantage of umbrella companies by many contractors.

Option 3: self-assessment

As well as PAYE and umbrella, there is also a third option available to contractors – working as a self-employed contractor through your own limited company.

With this option, contractors work off-payroll, meaning they carry out self-assessment and are responsible for making their own tax and National Insurance contributions. They still pay the same amount of tax, it is just processed and paid differently.

This option offers complete freedom to contractors to operate as they wish. However, it does also mean the contractor is responsible for running their own business, working out often complex tax returns, business admin and paperwork and a host of other things that are all part and parcel of running a business.

PAYE vs Umbrella: which is right for you?

Now you have weighed up all your options, if you have decided that working through an agency is the best route for you, the next step is to choose between PAYE or umbrella.

Now you know the key differences between each route, contractors can make a well-informed decision about which option is best for them.

Many contractors look to the most cost-effective option, however, as both options process tax through PAYE, the question shouldn’t be about cost, it should be more about whether the contractor wants the freedom and flexibility to choose their own contract work. If so, an umbrella company is the better option.

Thousands of contractors 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 which contracts you work on and when.

If you’ve decided the umbrella company route is for you, you will now need to find the best umbrella company to work with.

Find the best umbrella company with the help of Umbrella Broker

With Umbrella Broker’s handy umbrella calculator, we make it quick and easy for contractors to find the best company for their needs and requirements. Simply enter your details and we will generate a list of the best-suited umbrella companies for you. We take the hard work out of comparing umbrella companies, so you can get on with the important stuff. Why not see what our umbrella calculator can do for you today?

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