Contractors must make many important decisions throughout their careers, with one of the most significant being between PAYE vs umbrella. Although there are advantages and drawbacks to each option, for most contractors the decision comes down to which is the most cost and time effective for them.

So how can contractors work out which route will be the most cost effective for them? After all, in a world of contractor jargon and lingo it can be difficult to decide which option will be the best for you.

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That’s why Umbrella Broker have put together this comprehensive guide to PAYE vs Umbrella and which is the most cost effective option. We clearly lay out the differences between each option to help every contractor make an informed decision that will help to maximise their take home pay.

Option 1 – PAYE

Let’s first look at PAYE. PAYE simply refers to pay-as-you-earn which is the most common form of taxation in the UK.

Under the PAYE system, tax and national insurance contributions are deducted from the worker’s salary before it is paid to them in line with current UK tax bands. The majority of payroll workers are taxed under the PAYE system in the UK, with the exception lying with the self-employed.

Unlike employed workers who pay tax via PAYE, the self-employed are not on a company’s payroll and are therefore responsible for carrying out a self-assessment.

So, what does this mean for contractors?

Contractors that opt for the PAYE route will work under a PAYE agency who takes them on as an employee. They will be paid a salary by the agency which will be taxed under the PAYE system. The agency will source and secure contracts for the contractor, which the agency will choose.

Option 2 – Umbrella

That’s the PAYE option, so how does the umbrella route differ?

After all, many contractors face confusion when deciding between PAYE vs umbrella due to the fact that the two do not differ in terms of how and how much tax a contractor will pay under each option.

Just as with the PAYE option, a contractor that opts to work with an umbrella company will also be put on their payroll and taxed under the PAYE system. So, whether you operate under an umbrella company or PAYE agency, you will be taxed at the same rate in line with current tax bands.

What does differ between the two options is who the contractor works with and how this impacts the way they contract.

As we have mentioned, under a PAYE agency, the contractor has no choice when it comes to which contracts they work on. The PAYE agency sources and selects projects and the contractor must carry these out.

On the other hand, contractors operating through an umbrella company are free to choose which contracts they work on and when. For contractors that prefer a greater level of freedom and flexibility, this often means that an umbrella company is the better route.

Option 3 – Limited company

When making the choice between PAYE and umbrella, it is worth noting that there is another option –  working under a limited company.

With this route, the contractor will be self-employed and operate under their own limited company. Here, the contractor will be responsible for carrying out self-assessment and making their own tax and National Insurance contributions after they have been paid their contractor fee.

That means the contractor will not be employed by an agency or company and therefore will not pay tax through the PAYE system.

Although this can be the most tax-efficient way of contracting, with the changes to IR35 legislation set to come into play in Aril 20201, many contractors are turning away from this route, instead opting to be employed by a PAYE agency or umbrella company in order to ensure IR35 compliance.

Another drawback to this option is that it is generally more time consuming. Contractors have to set up and run their own business, inclusive of the admin and paperwork required for this as well as often complex tax and accounting calculations.

PAYE vs Umbrella: which is the most cost effective option?

Now you have a clear breakdown and overview of each option and what they entail, many contractors will want to know which is the most cost effective option, PAYE vs Umbrella.

The short answer is, however, that as the contractor will be charged the same levels of income tax and National insurance under a PAYE agency and umbrella company, neither option is more cost effective than the other.

So, when it comes to making your decision, you should instead look at the pros and cons of each to determine which route is best suited to you:

PAYE pros and cons:

  • Pros: a PAYE agency is simple and easy to join and will entitle contractors to statutory employee rights and benefits.
  • Cons: with the PAYE agency route, contractors cannot choose what contracts they work on, they cannot claim back expenses and aren’t usually given the continuity of employment meaning they won’t receive one handy tax code.

Umbrella pros and cons:

  • Pros: umbrella companies are also quick and easy to join and entitle the contractor to the same statutory rights and benefits as employees. However, unlike under a PAYE agency, under an umbrella company contractors can claim back business expenses which can be offset against their tax bill and they are given continuity of employment and therefore one handy tax code. Umbrella contractors receive the freedom and flexibility to choose which contracts they work on and when which is a big appeal for many.
  • Cons: if you want the ease of having projects chosen and booked in for you, this is not the best route.

Weighing up the pros and cons of each option, contractors can make a well-informed decision catered towards their own needs and preferences.

Many contractors will take the umbrella route which gives them the freedom to choose which contracts they work on, with the security of being employed by the company. If this sounds like the best path for you, the next step is to find the best umbrella company.

Use Umbrella Brokers Umbrella Calculator

With lots of umbrella companies out there offering different benefits and perks, it’s important that contractors do their research to find the best umbrella company for them. That’s where our handy umbrella calculator comes into play. Simply enter your details and we’ll give you a list of the best umbrella companies for your needs in just 60 seconds.

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