Becoming a Contractor: Limited Company vs an Umbrella

From a better work-life balance to a higher rate of pay, the benefits of becoming a contractor are vast. Early on in your contracting career you'll want to work out the best trading arrangement for you. There are two main options, and your choice will usually depend on the detail of your contract and whether you see yourself contracting in the long term.

Trading through your own limited company:

As the director of your own limited company you’ll have access to legitimate tax planning opportunities that are not available to employees, so you’ll usually get to keep more of your contracting income. The agreed contract rate is paid to your limited company and you then have a great deal of flexibility in how your company pays you. This will usually involve a small salary combined with a dividend, but a specialist contractor accountant will advise you how best to proceed.

It’s more work than the alternative and it has fixed costs attached, so it’s generally more beneficial for higher earners and we’d only recommend it if you see contracting as a long-term career. It’s quite common for new contractors to start with umbrella employment and switch to their own limited company once they’re established and certain that the contracting life is for them.

You will need to make provision for your own time off, including holiday and sick pay, as your company will only be paid when you work. However, many contractors find that the difference in their income makes up for the need to make their own arrangements.

Umbrella employment:

As the name suggests, the other option is to be employed by an umbrella company. The strength of umbrella is that it allows you to combine the freedom and flexibility of contracting with the security and stability of employment.

The agreed contract rate will be paid to the umbrella company who will cover their costs and pay the remaining amount to you through PAYE, making all necessary deductions for income tax and national insurance before paying you. This means that the amount paid to you is your net pay, and you won’t need to complete a tax return unless you have income from other sources.

From the contractor’s point of view, umbrella employment is extremely easy. You just submit a timesheet and maybe an expense claim each week and the umbrella company takes care of the rest. The umbrella company is your employer so you have the rights, protections and benefits afforded to all UK employees, including sick pay, maternity/paternity pay, access to a workplace pension and holiday pay.

Which option should you choose?

Your choice of working arrangement will depend on lots of different factors, many of them personal to you. For example, how comfortable are you with the responsibility of being a company director? Would you rather have less administration to do or have complete control of your career and finances? Is it more important that you’re tax efficient, or that you know you’ll be paid when you’re ill? For this reason, we advise you to talk your personal situation over with an expert so you can come to an informed decision based on the factors that matter most to you.

We usually recommend trading through a limited company to those who see contracting as a long-term career choice, command higher contract rates and consistently work outside IR35. This means that you’re genuinely in business for yourself providing services for your client, rather than working as a “disguised employee”. Trading through your own limited company can be extremely rewarding, both financially and in terms of autonomy, flexibility and work/life balance, but it also comes with considerable responsibilities and represents a commitment that many first-time contractors are not willing to make.

Umbrella employment is usually a better choice if you’re not sure you’ll be contracting in the long term, or if you don’t want the responsibility of being a company director. Those on lower contract rates or working inside IR35 may find that they’re better off with umbrella.

Being employed, and having one employer for all your contracts, can be very convenient and is a more comfortable situation for many new contractors. It’s quite common for umbrella to be used as a “gateway” to contracting, as you can always “go limited” at a later date.

Written by our umbrella partner, Orange Genie.

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Katie Banbury

23rd August

Career Advice