Contractors have to make many decisions in their careers, with one important one being whether they will work through PAYE or umbrella.
Both the PAYE and umbrella options have their advantages and drawbacks. The best option will depend on your circumstances and requirements as a contractor, meaning it’s important to do your research in order to find the best way of working for you.
To help make things easier, Umbrella Broker outlines the differences between PAYE and umbrella, so you can answer the all important question of which is better for you.
PAYE vs Umbrella: What is the difference?
There are several key differences between PAYE and umbrella.
Firstly, let’s look at what PAYE is and what it means.
PAYE, or pay-as-you-earn, refers to a way of paying income tax, where UK workers will pay levels of tax depending on how much they earn.
This is the most common way of paying tax, with most employees paying tax in this manner unless they work off-payroll.
Off-payroll workers instead pay tax through self-assessment, either on an annual, quarterly or monthly basis. Unlike PAYE workers, whose tax is deducted as they earn, off-payroll workers pay tax after their income and outgoings have been processed and paid.
PAYE workers will pay tax in line with current tax bands. For 2021-2022 these stand at:
- Tax-free Personal allowance: up to £12,570 per year
- Basic rate (20%): £12,571 – £37,700 per year
- Higher rate (40%): £37,701 – £150,000 per year
- Additional rate (45%): over £150,000 per year
So, if a contractor chooses the PAYE option, they will be employed by a PAYE agency and their salary will be processed through the PAYE system according to current tax bands.
However, some contractors may get confused due to the fact that with both the PAYE and umbrella company options, tax is paid in the same way, namely through the PAYE system.
So, what are the differences?
Difference 1: How to source contract work
The main difference between PAYE and umbrella is how the contractor operates under each.
With a PAYE agency, the contractor is told what contracts they will work on and when they will work on them.
On the other hand, umbrella contractors can select which projects they will work on, when, and with which clients.
Which option you prefer is up to the contractor’s personal preference, however many contractors will enjoy the freedom to choose their own contract work. After all, this means they can go after contracts that are of high value to them and progress in their careers at a pace that’s right for them.
Difference 2: Continuity of employment
Another key difference when it comes to PAYE or umbrella is continuity of employment.
An umbrella company will offer the contractor continuity of employment, meaning that although the contractor works on different projects and contracts throughout the tax year, they will be given one handy tax code.
A PAYE agency, however, does not offer continuity of employment. This means the contractor does not get just one tax code in the financial year.
For this reason, many contractors prefer the umbrella company route as it means that their taxes are kept simple and makes things such as getting a mortgage or loan approved a whole lot easier.
Difference 3: Who can claim for expenses
Another difference between the two ways of working is whether the contractor can claim expenses.
Typically, umbrella companies allow contractors to claim back expenses. This is considered a big bonus to contractors as legitimate business expenses can be offset against the contractor’s tax bill.
On the other hand, PAYE agencies do not usually let contractors claim back expenses, meaning PAYE contractors miss out on these tax advantages.
Difference 4: Statutory rights
The final difference between PAYE and umbrella is statutory rights.
Every umbrella company offers the contractor statutory benefits. These include sick pay, holiday pay, maternity and paternity pay and a workplace pension.
Just as it sounds, this is considered a huge advantage of the umbrella company route to contractors. After all, it means the contractor will still get paid if they wish to take a well-earned break, fall unexpectedly ill or are planning on having children.
A PAYE agency, on the other hand, does not entitle contractors to statutory benefits.
This means that PAYE contractors don’t enjoy the security of statutory pay should they go on holiday or become sick. Instead, these contractors will not get paid if they do not work.
What are the next steps?
Now you know the main differences between PAYE and umbrella it’s time to decide which is the best route for you.
As an umbrella company offers greater benefits to the contractor in terms of allowing them to claim expenses, giving them continuity of employment and statutory benefits, many contractors will decide this is the way forward for them.
If this is the case for you, you will next need to find the best umbrella company to work with. That’s where Umbrella Broker comes in handy.
