Pay-as-you-earn (PAYE) vs umbrella company – it’s a choice faced by thousands of contractors across the UK. At Umbrella Broker, we want to focus on what’s best for you – and for many, it comes down to which is most cost and time-effective.

In this post, we’ll discuss the pros and cons of PAYE vs umbrella companies and which is best to maximise your take home pay.

What exactly is PAYE?

Pay-as-you-earn (PAYE) refers to the standard form of income tax in the UK. Tax (and national insurance) is deducted from your salary before it is transferred to you. It differs from a tax return, where individuals or businesses pay their tax annually, quarterly or monthly after they have processed income and other outgoings.

PAYE is by far the most common form of taxation. Most full-time and part-time employees taxed use the system. The exceptions? People who are paid off-payroll, working for someone as a self-employed contractor or consultant. They provide their services on a non-permanent basis. This is why they’re not added to that company’s payroll and not classed as an employee.

PAYE tax rates

For April 2019 – April 2020, the PAYE system uses the following tax rates, based on your annual income:

  • Personal allowance (tax free) – Up to £12,500 a year
  • Basic rate (20%) – £12,501 to £50,000 a year
  • Higher rate (40%) – £50,001 to £150,000 a year
  • Additional rate (45%) – More than £150,000 a year

Despite common misconceptions, you aren’t taxed at a certain rate for your entire income. Instead, anything you earn up to £12,500 will be tax-free. Anything you earn between £12,501 and £50,000 will be taxed at 20% – and so on. So, someone earning £200,000 in a year will still receive the same tax-free allowance as someone earning £20,000.

These allowances and tax rates are worked out monthly. You could be taxed at a higher rate one month and then refunded at a later date if your annual income eventually falls into a lower tax band.

PAYE vs umbrella

Technically speaking, umbrella companies do not differ from PAYE. They hire contractors as employees, adding them to their payroll and processing their income using PAYE taxation. What does differ, however, is who you’re choosing to process your income through PAYE.

In short, contractors can choose between agency PAYE or umbrella company PAYE. With an agency, you will work through them and be employed by them. As a result, they will process your salary through their payroll as PAYE. However, they will also determine which jobs you take on and when you work.

In contrast, umbrella PAYE allows you to operate with more freedom. It’s essentially a way of working through PAYE without having to complete a tax return. Working with an umbrella, you can work through recruitment agencies if you choose to do so, but also acquire your own work as and when you wish.

One further difference is that umbrella PAYE includes deductions for employers’ national insurance (ENI). With regular PAYE, this is paid by the employer. However, to reduce the umbrella processing fee, umbrella companies will deduct it from your gross pay, alongside their fees.

In comparison while the same amount of tax will be paid to HMRC, contractors stand to be worse off through Umbrella PAYE due to the deduction of ENI. For this reason it’s important that contractors negotiate a higher relative day rate than their employed counterparts.

PAYE vs self-assessment

It’s also worth considering the option of self-assessment as a contractor. When it comes to PAYE vs self-assessment, there’s actually no difference in income tax rates. Both use the same rates (personal allowance, basic rate, higher rate, additional rate). The only difference comes in how this tax is paid. While PAYE is paid before you get your wages – as you earn – self assessment tax returns require you to pay the tax you owe for a given period, whether it’s a month, quarter or year.

Which is most cost-effective?

Because they use the same tax-rates, the question of PAYE vs umbrella vs self-assessment isn’t so much about which is most cost-effective. It’s more important to consider which is the best fit for you.

Do you want the complete independence of self-assessment, which requires more work on your part? Or would you prefer the ease of a recruitment agency, who will find you work and process your salary through PAYE (provided the day rate is worth it)?

For many, the best option is working through an umbrella company, as this combines the two to provide the best of both worlds. You still have the freedom to work on whichever contracts you choose, without the hassle of self-assessment tax returns.

Indirect Costs

That said, there are a few indirect costs that could make some options more appealing…

Firstly, umbrella companies and recruitment agencies will often take a slice of your income as a fee for their services. While that will slightly reduce your take-home pay, they do offer a number of benefits in return, not least the fact that they take care of tax and national insurance.

There’s also holiday pay, sick pay and paid maternity or paternity leave, which could be invaluable when it comes to your work/life balance.

On the flipside, consider the complexity of self-assessment. While most contractors think they will go it alone, you may need to get assistance from an accountant, which could cost quite a bit if it becomes a recurring expense.

It can also be much more difficult to manage your income when you’re working on a quarterly or yearly basis, as you have to keep track of what you owe and be prepared to pay a lump sum to HMRC when the time comes to pay your taxes. This requires a lot of self-control and forward planning, as you will need to put funds to one side as you go.

Find the best umbrella PAYE provider

Working through an umbrella company is a beneficial option for contractors in all kinds of roles and sectors. But it’s important to compare companies and find the best provider for you.

At Umbrella Broker, we want to make umbrella company comparison easy. Using our umbrella comparison site, you can compare multiple umbrella companies based on your income, with a clear idea of the costs and your take home pay.