PAYE or umbrella? It’s a question asked by countless contractors who want to make the most of their earnings. However, it’s also important to consider your situation, like how much spare time you have, to find the option that’s best for you. While PAYE (pay-as-you-earn) may give you a bit more take-home pay, for instance, it would require a lot more legwork.

So, how do you know which is best for you? Read on as we look at five signs that you should choose PAYE over an umbrella company.

PAYE vs umbrella

First things first, what’s the difference between PAYE and umbrella taxation? In terms of tax, they’re actually the same. Contractors working through an umbrella company will be taxed through pay-as-you-earn (PAYE). That means you’ll be subject to the same rates of tax and national insurance as a regular employee or self-employed contractor.

As of April 2019, they are as follows:

  • Tax-free personal allowance – Up to £12,500 a year
  • Basic rate of 20% – £12,501 to £50,000 a year
  • Higher rate of 40% – £50,001 to £150,000 a year
  • Additional rate of 45% – More than £150,000 a year

To clarify, these rates are charged only for the income that falls within the relevant brackets. So, someone earning £55,000 won’t be charged the higher rate for their entire income. Instead, they’ll get the tax-free personal allowance up to £12,500, 20% tax on anything between that and £50,000 and 40% tax on the remaining £5,000.

On top of that is national insurance, which is charged at 12% on earnings over £166 a week (£8,628 a year) and 2% on anything over £962 a week (£50,000 a year)

The difference between the two

PAYE and umbrella companies differ in terms of fees, admin and benefits. Umbrella companies will add you as an employee, process your invoices and tax for you and provide statutory benefits, including sick pay, holiday pay and maternity or paternity leave. However, in return, they will take a monthly fee from your wages before processing them for tax and national insurance.

On the flipside, paying PAYE tax yourself will mean completing an annual self-assessment tax return annually, quarterly or monthly. With that in mind, here are five signs that PAYE is the right choice for you:

1.   You have plenty of time

Completing tax returns every year, or even more regularly, takes a lot of time even if you know what you’re doing. Of course, if you’ve got that time to set aside every month, working directly through PAYE could be a good option. But remember that even if you’re completing your self-assessment tax return annually, you will need to spend some time on it throughout the year to keep things in order.

2.   You’re competent with tax

Albert Einstein reportedly described income taxes as the hardest thing in the world to understand. As well as the multiple bands and types of tax, the rates will inevitably change year upon year…

For most of us, including Einstein, this is simply too much to keep track of. It’s easy to make a number of common mistakes, which could be costly. That’s exactly why contractors and businesses will use expert accountants – or an umbrella company that takes care of it for you. However, if you’re 100% confident in your understanding of tax, PAYE could be better for you.

3.   You’re well organised

Understanding tax is one challenge. Staying on top of it is another job entirely. If you’re paying tax directly through self-assessment PAYE, you need to have impeccable organisation to meet self-assessment deadlines. Around 700,000 people missed the self-assessment tax deadline in 2019, with a further 700,000 submitting their returns on the deadline day.

Missing the deadline results in an initial fixed penalty of £100, with an additional penalty of £10 per day (up to £900) and a 5% charge (or £300) after 6 and 12 months. These kinds of charges would eliminate any financial benefit of working directly through PAYE, so it’s important that you’re ready to stay organised if you do choose this route.

4.   You’re good with money

Another requirement of self-assessment PAYE is that you pay your tax bill after your income has been sent to you. You’re responsible for invoicing clients and will receive the full amount from them with no tax deductions. That income isn’t yours to keep. Later in the month, quarter or year, you’ll need to work out your tax bill and pay it in full.

If you’ve already spent it, this could result in a hefty tax bill that you simply can’t afford. Contractors should only choose PAYE self-assessment if they’re good with money and prepared to keep track of the tax they owe throughout the year. Otherwise, you could end up in a tricky financial situation.

5.   You can fund your own statutory benefits

Finally, PAYE is a good option if you don’t need statutory benefits – or are prepared to fund them yourself. Paid holidays, sick leave and maternity or paternity pay, along with a workplace pension, will all be part of your umbrella company contract. However, working through PAYE yourself, there will be nobody there to provide them for you.

It’s not realistic to say you’re not going to take time off work or you’ll never be sick, so you need to have something in place to fund them. If you’re happy to set money aside for these periods – and set up your own pension scheme – PAYE might be a practical option.

PAYE or umbrella – the verdict

Whether it’s the administrative burden, the complexity of tax or the statutory benefits, there are a range of factors to consider before working through self-assessment PAYE. If you understand them all and you’re prepared to take them on, it could be a good option.

However, if you want to keep things simple, you’re probably better off with an umbrella company. That’s where Umbrella Broker can assist you. With our umbrella company comparison site, you can find the best umbrella company for your needs. Simply enter your details and estimated income to see full break down from multiple providers. No call-backs and no complications.