Switch to Limited Company or Keep Using Umbrella?
How to Choose Between Setting Up a Limited Company and Using an Umbrella Company
It doesn't matter whether you're just starting out as a contractor or you're looking to change your current business setup, the choice between setting up a limited company or using an umbrella company can have a big impact on your business. Both have an impact on your take-home pay, workload and administrative responsibilities, and contractors fall into two camps in regards to which is best. It's not a decision you'll want to rush into, not before you do your research.
At Go Limited, we know that limited companies and umbrella companies both have things to offer a contractor. To determine which is right for you, you need to consider whether an umbrella company or limited company best aligns with your professional goals.
Limited Company vs. Umbrella Company: Key Differences Every Contractor Needs to Know
When it comes to deciding between setting up a limited company and using an umbrella company, you need to understand what sets these two ways of structuring a business apart. Though there are similarities, they're by no means the same.
A limited company is a separate legal entity that you own and manage, as a director. You are responsible for invoicing your clients, handling your taxes and making sure that you're compliant with everything set out by HMRC. Contracting through a limited company gives you a lot of control and flexibility, even providing you with ways to be more tax-efficient. However, it also means taking on a whole host of admin tasks - such as bookkeeping, tax filings and IR35 regulations - that you might not be too familiar with.
An umbrella company is different, as it's not a company that you own. Instead, it's an intermediary between you and your client. When you use an umbrella company, you become an employee of that umbrella company and they handle all the invoicing, pay and deductions, giving you a lot less to think about. But, you won't have as much freedom to become more tax-efficient, and you'll pay a fee for their services.
Take-Home Pay: Umbrella vs. Limited
When you're choosing between setting up a limited company and using an umbrella company, you'll need to consider the impact each will have on your take-home pay. When you're working hard to provide services to clients, you'll want to know that you're maximising your income.
Limited Company Take-Home Pay
If you're contracting through a limited company, you have the advantage of being able to structure your income in a tax-efficient way. By paying yourself a salary that's on the smaller side, and taking the rest as dividends, you'll benefit from a slightly lower tax rate. Whereas salaries are taxed at a rate of 20% for basic taxpayers, dividends are taxed at a lower rate of 8.75%. There's even benefits for higher rate taxpayers, with rates of 40% and 33.75%. This approach to take-home pay means that contractors working through a limited company often enjoy a higher take-home pay compared to those working through an umbrella company.
Umbrella Company Take-Home Pay
There's no denying the appeal of an umbrella company, especially when it comes to the simplicity of managing your earnings. There's no need to find the perfect balance between salary and dividends, and you don't need to think twice about working out how much tax you need to pay. An umbrella company automatically deducts tax and National Insurance contributions (NICs) just like a regular employer would, handling everything for you. But, without taking some of your income as dividends - and having to pay fees for the umbrella company's services - umbrella company take-home pay tends to be lower. It's a straightforward approach to contracting, but this generally means you have less control over your income and the amount of tax you pay.
To put it simply, a limited company gives you the opportunity to enjoy a higher take-home pay, whereas an umbrella company provides simplicity and security, but at the cost of slightly lower earnings. You'll need to consider what's more important to you, and which is going to help drive your business forward.
How to Transition from an Umbrella to a Limited Company
If you've decided that setting up a limited company is right for you, you'll need to transition from an umbrella company. It's not uncommon for contractors to initially work under an umbrella company, and then transition to a limited company as a way to boost their business.
Set Up Your Limited Company
As you might have guessed, the first step of setting up a limited company is to register your company with Companies House. You'll need to choose a company name and designate directors - more often than not, contractors are the sole directors of their companies, until the business grows at least - and decide on your company's structure. Once your limited company is registered, you'll receive your company number and you can start trading.
Open a Business Bank Account
Whereas sole traders and freelancers can use their personal bank accounts for business purposes, setting up a limited company means having to open a business bank account. This will help you to track expenses and manage your cash flow effectively, without getting personal and business costs mixed up. There are a lot of business bank accounts to choose from, many of which offer financial services alongside traditional banking services.
Organise Your Accounting and Tax
As a contractor with a limited company, you'll need to organise your accounting. A lot of contractors choose to hire an accountant, but you can do it yourself by using recommended accounting software, as long as your understanding of accounts and tax is up to scratch. As a limited company contractor, you'll be responsible for managing your accounts, submitting your tax returns and paying Corporation Tax on your profits.
Notify Your Clients
If you've been working for clients through an umbrella company, you'll need to let them know that you've transitioned to a limited company. They may need to update their records and ensure that they're invoicing you correctly, especially if setting up a limited company has changed whether you're working inside or outside IR35.
Finalise the Umbrella Relationship
The last stage of moving from an umbrella to a limited company, is finalising the relationship you've had with the umbrella company. This involves notifying them that you'll be saying goodbye to their services. It's important to settle any outstanding invoices and confirm your final pay details before you move on.
Umbrella Company or Limited Company, Which is Right for You?
Once you've familiarised yourself with the differences between limited companies and umbrella companies, you'll find it a lot easier to choose between the two.
Should You Choose an Umbrella Company?
If you're new to contracting or you tend to work on short term contracts, and don't want to deal with the complexities of running a business, you might find an umbrella company appealing. It's a simple, hassle-free approach to contracting, and it's ideal if you want to keep your tax, financial and administrative affairs simple. You also might want to choose an umbrella company if you want to guarantee that you're compliant in regards to IR35, as making a mistake can be costly. With an umbrella company handling your tax deductions, there's less risk.
A lot of contractors who enjoy having the flexibility of working for various clients, without the commitment of managing their own business, choose an umbrella company. You have the freedom to work with various clients and on different projects, without the stress that comes with being a limited company director.
Should You Choose a Limited Company?
If you're planning to contract for the foreseeable future and you're ready for more responsibility, setting up a limited company could be the perfect choice for you. Though you'll have to handle everything that comes with managing a business - such as handling your own income, expenses, tax payments, corporate tax and NICs - you'll also be able to maximise your earnings through tax-efficient salary and dividend options.
To ensure that setting up a limited company is successful, you need to be comfortable with handling your own accounting or hiring an accountant to manage your tax returns. But, the take-home pay and tax benefits that come with being a limited company contractor tend to outweigh this extra responsibility.
FAQs
What is the difference between a Limited Company and an Umbrella Company?
A limited company is a business you set up and own, giving you control over finances, contracts, and tax planning. An umbrella company acts as an employer for contractors, managing payroll and tax deductions under PAYE.
Which is better: Umbrella Company vs Limited Company?
- Limited Company: Best for long-term contracting, greater tax efficiency, and contracts outside IR35.
- Umbrella Company: Ideal for shorter contracts, minimal admin, and contracts inside IR35.
How do I compare take-home pay: Umbrella vs Limited?
- Umbrella Company: Typically retains 55-65% of your income after tax.
- Limited Company (Outside IR35): Can retain 70-80% of earnings due to dividend tax advantages.
What factors should I consider when choosing between an Umbrella and a Limited Company?
- IR35 Status – If inside IR35, an umbrella company may be easier.
- Contract Length – Short-term? Umbrella. Long-term? Limited company.
- Admin Work – Limited companies require more paperwork and financial management.
- Take-Home Pay – Limited companies offer better tax efficiency for outside IR35 contracts.
Can I switch from an Umbrella to a Limited Company?
Yes, the transition from umbrella to limited company involves:
- Registering a Limited Company with Companies House.
- Opening a business bank account for company transactions.
- Registering for Corporation Tax, VAT (if applicable), and PAYE.
- Ensuring your contracts are IR35 compliant to maximise tax efficiency.
Can I switch back from a Limited Company to an Umbrella Company?
Yes, if your contract moves inside IR35 or you want to avoid administrative work, you can close your limited company and move back to an umbrella company.
How does IR35 impact my choice: Limited Company vs Umbrella Inside IR35?
If inside IR35, a limited company provides no tax benefits since income is fully taxed under PAYE.
An umbrella company may be a simpler choice as it takes care of PAYE deductions and compliance.
What is the main difference between PAYE Umbrella and Limited Company PAYE?
- PAYE Umbrella: Your tax and National Insurance (NI) are deducted before you receive your salary.
- Limited Company PAYE: You run your own payroll but must manage taxes, NI, and Corporation Tax.
What is the difference between a Personal Service Company (PSC) and an Umbrella Company?
A Personal Service Company (PSC) is a type of limited company owned by a contractor. If inside IR35, a PSC is treated like an umbrella company for tax purposes, meaning income is subject to PAYE deductions.
How do Parasol vs PayStream compare for umbrella services?
Both Parasol and PayStream offer umbrella company services, handling payroll and tax compliance for contractors. The best choice depends on:
- Fees
- Contractor support
- Reputation and compliance
Is an Umbrella Company a Limited Company?
No, an umbrella company is not the same as a limited company. It is a separate entity that acts as an employer for contractors.
Which is best for a contractor: a Limited Company or an Umbrella Company?
- Limited Company: More profitable if you are outside IR35 and working long-term.
- Umbrella Company: Easier for contractors inside IR35 or those preferring a hassle-free approach.
How does PAYE vs Umbrella vs Ltd compare for contracting?
- PAYE (employed work): Stable income, employer handles tax.
- Umbrella Company: Best for short-term contracts and IR35 roles.
- Limited Company: Best for tax-efficient contracting outside IR35.
What happens if I choose a Limited Company but later fall inside IR35?
You will need to pay PAYE tax and NI on earnings from that contract. Many contractors in this situation switch to an umbrella company for simplicity.
Should I compare Limited Company to PAYE if I'm considering permanent employment?
Yes, permanent employment (PAYE) vs Limited Company decisions depend on:
- Job security vs contract flexibility
- Employee benefits vs higher earnings
- Admin responsibilities
Which is the best option for me: Contracting Umbrella or Limited Company?
- If you want less admin, full employment benefits, and work inside IR35 → Choose an umbrella company.
- If you want higher take-home pay, control over finances, and work outside IR35 → Set up a limited company.
At Go Limited, we know how hard it can be to decide between setting up a limited company and using an umbrella company. After all, there are pros and cons to each. But, if you ask our experts, they'll tell you that setting up a limited company tends to be the right choice. Not only do you benefit from maximised take-home pay and reducing your tax liabilities, but you also benefit by having control over how your contracting is structured.
