Umbrella company, PAYE vs limited company: which is better for contractors?
If you’re a contractor and start a placement through a recruitment agency, you’ll be offered a choice of payment structures.
This includes PAYE through the agency’s payroll and employment under an umbrella company, each of which has unique benefits. Alternatively, you may decide to set up your own limited company.
There’s no right or wrong answer when it comes to choosing, but it’s important to make an informed decision as it ultimately impacts your take home pay and level of autonomy.
Read on to learn what each of these options are and the differences between them.
The options and who they are suitable for
Agency PAYE refers to being added to the recruitment agency’s payroll. This means you will work for and be paid by the agency that will make any relevant payroll deductions (i.e. taxes or contributions).
This is the best option if you’re seeking occasional temporary jobs, such as bar work, as each contract is treated separately. Some agencies offer ‘pay between assignments’ contracts for any gaps between projects, but it’s worth assessing the pros and cons of these on a case-by-case basis.
Your agency may refer you to an umbrella company that will pay your salary on their behalf. The agency will likely offer you some options on their preferred supplier list (PSL), but make sure you conduct independent research.
When you join an umbrella company, you become an employee which means you gain some great employment benefits. Because of this, an umbrella company is ideal if you’re working on several short-term assignments with various agencies and would like continuous employment.
Want to find out more about the umbrella company structure? Return to our complete guide to umbrella companies.
Limited company (LTD)
A limited company is a popular business structure in the UK. It allows you to create a business as a separate entity, meaning you and any shareholders keep your personal finances protected should the business fail (unlike a sole trader status).
It’s the most tax-efficient option, making it a good choice if you earn more than £35,000 a year and you’re willing to take more responsibility for your finances.
The key differences between agency PAYE, umbrella, and LTD
Taxes and compliance
- Both agencies and umbrellas cover tax returns and accounts. This means you’ll have no financial responsibilities aside from submitting timesheets.
- If you set up a limited company, you’ll be fully responsible for handling your tax duties – or you can hire an accountant to do it for you.
- Under an umbrella company, you’re exempt from IR35 as you become an employee.
- Contractors under agency PAYE and registered limited companies (or personal service companies) may be subject to IR35. Get the latest updates on gov.uk.
Take home pay
- Umbrella companies calculate any tax relief on allowable business expenses, which could result in increased pay. However, umbrella companies take a margin for their service and benefits. Some agencies may uplift your contracted rate to cover these costs.
- Your salary through agency PAYE will vary in comparison to an umbrella company. While there are no admin charges, you’re not eligible for as many expense claims.
- As a limited company, you’ll receive greater financial protection. You’ll be paid by the agency business-to-business (B2B) and not as an employee, meaning you’ll take home more pay due to no employee-related deductions. However, you an accountant can free up your time and ensure compliance – which of course comes at an additional cost.
- Umbrella and agency PAYE give you access to certain statutory benefits including sick pay and parental leave. Better ones provide cover for you to complete your work.
- An umbrella company may provide additional perks like health insurance, life cover, and accident cover. Other benefits may include access to insurance like professional indemnity and public liability, plus the ability to claim costs and expenses. As you’ll have one tax code regardless of the number of agencies you work for, this means you’ll have a set payday, one tax code, one pension pot, and one P60.
- As you aren’t an employee as a limited company, you will not receive the above worker benefits. This also means you won’t receive holiday pay.
- If you’re on an agency’s payroll, you’re considered an agency worker and every project you complete will be under a new contract. This means you could face gaps in your employment between jobs, and all projects will be selected by your chosen agency.
- Under an umbrella company, you will be considered an employee. A huge benefit of this is that you will be under a contract of employment, regardless of the number of projects you take on. This means you will have a record of continuous employment, ideal for mortgage and loan applications. Your employer will always be the umbrella company, and not the different end clients you work with. Ultimately, you’ll be able to operate with more freedom.
- If you set up a limited company, you’ll be the director of your business. This means you’ll receive B2B payment, as opposed to being on an agency’s or umbrella company’s payroll.
- Working with an agency is easy as it cuts out any third parties, plus they’ll work out any deductions and benefits on your behalf. To get started, you simply provide your details via an application form with supporting documentation. When you begin work, you’ll need to log expenses and timesheets so your pay can be calculated.
- Signing up to an umbrella is simple and can take a matter of minutes. You’ll just need to include details of your umbrella company in your agency application. Once you’re set up, you remain employed across different contracts. Like an agency, your tax deductions will automatically come out of your salary, so you won’t have to worry about these yourself. You’ll also only need to provide timesheets and expenses.
- Setting up a limited company requires you to register with Companies House which can sometimes be tricky. If you need support, company formation advisors can help you through the process at a small cost. You’ll also need to manage your accounts, including tax returns, unless you hire an accountant to do it for you.
Let’s quickly compare and contrast the different options against each other to help you determine your best option.
Umbrella company vs limited company (LTD)
An umbrella company offers a more straightforward option than setting up an LTD as it takes tax responsibilities away from you, and you’ll be exempt from IR35. It also offers the stability of continued employment which makes it easier to get mortgages, loans, and so on.
On the other hand, a limited company offers greater financial freedom, and it usually enables the greatest take-home pay. So, when you’re weighing up umbrella vs LTD, it comes down to whether you prioritise simplicity or net pay. The potential for extra earnings via a limited company comes at the cost of greater responsibility.
PAYE vs umbrella company
An umbrella company offers continued employment, ideal for longer contracts and the increased ability to apply for mortgages and loans. You may have more worker benefits than an agency worker too – but you can expect to pay around £100 per month for the service. However, an agency is ideal for occasional temporary jobs as each contract is separate.
PAYE vs limited company (LTD)
A limited company offers you the highest level of financial freedom, but this of course comes with greater liability. Setting up and managing a limited company requires ongoing maintenance, while PAYE is managed by the recruitment agency.
An agency manages your pay deductions and offers worker benefits, while under a limited company you’re in charge of your accounts. It’s therefore a case of considering how much autonomy you want in managing your placements.