Take Home Pay - Umbrella or Limited?
Comparing Umbrella Companies and Limited Companies for Contractors
Regardless of the industry that you work in, you'll want to make as much money as you can. There's a lot of hard work and dedication that comes with being a contractor, and you'll want to be rewarded for that. This is why it's important to compare your take-home pay when working under an umbrella company vs. a limited company. You're always going to have to pay tax, but some approaches to contracting are more lucrative than others.
At Go Limited, we know there's a lot to think about as a contractor, but we're here to help. If you're contracting at the moment - whether that's as a sole trader, or if you're already part of an umbrella company - you might be considering setting up a limited company. If that's the case, you'll need to know how your take-home pay could be impacted. Luckily, setting up a limited company usually means good things for your bank account.
Umbrella Company vs. Limited Company: The Key Differences
When it comes to making the most of your income by increasing your take-home pay, knowing the differences between an umbrella company and a limited company will help in a big way.
- Umbrella Company - An umbrella company acts as an employer, employing you as a contractor. It handles payroll, taxes and administrative tasks, paying you through PAYE and managing your tax before you're paid. Though you'll have limited control over your finances and business decisions, as the company manages everything on your behalf, you do benefit from the convenience that comes with having minimal administrative responsibility.
- Limited Company - A limited company is a separate legal entity that you own and manage as a director. You can set up a limited company, contract as you would normally, but without being tied to your business in a legal sense. You are responsible for the business's operations, finances and compliance, and you have full control over how you operate, including managing your income and expenses. Setting up a limited company offers more options for tax efficiency, branding and business growth. But, the downside is it involves more admin and legal obligations, such as filing annual accounts and paying your own tax.
Now you know the difference between an umbrella company vs. a limited company, it's time to look at why your take-home pay will be different depending on which route you take.
Why Does Take-Home Pay Change?
A lot of contractors make the decision to contract under umbrella companies or to set up a limited company based on take-home pay. Your take-home pay is likely to change depending on how your income is taxed and what deductions apply, and both approaches have an impact on this.
For example, working under an umbrella company means that you're paid through the PAYE system. This means that all of your income is taxed at the standard PAYE rates, with deductions for income tax and National Insurance (NICs) contributions. You'll also have to pay fees, as umbrella companies change for their services, which reduces your take-home pay even further. But, in response to this, working under an umbrella company does mean that you receive statutory benefits - like holiday pay, sick pay and maternity or paternity leave - which are factored into your income.
If you go down the limited company route, you have to manage the tax side of things yourself. But, limited companies do give you the ability to split your income between a small salary and dividends, which are taxed at lower rates than income. You can also claim business expenses to reduce your corporation tax liability. Though there are additional administrative costs - for example, if you're not confident with finances and managing your tax, you'll need to hire an accountant to help - the tax savings often result in higher take-home pay.
The Take-Home Pay Benefits of Moving from an Umbrella Company to a Limited Company
- Tax Efficiency - Contracting through a limited company allows you to pay yourself in a combination of salary and dividends. Dividends are taxed at lower rates than income, reducing your overall tax liability, compared to being paid through PAYE under an umbrella company.
- Claimable Expenses - As a limited company director, you can claim a wide range of business expenses, such as travel, equipment, utilities, rent and professional training, which will reduce your taxable income.
- VAT Advantages - Registering for VAT can help you to retain some of the VAT charged to clients, boosting your earnings. This isn't an option with an umbrella company, as you're treated as an employee for tax purposes.
- Avoiding Umbrella Fees - Umbrella companies charge weekly or monthly fees for their services, which will reduce your take-home pay. As a limited company owner, you don't have this cost, as you're the one managing everything.
Umbrella Company Take-Home Pay
Managing your take-home pay through an umbrella company is simple and straightforward, and you don't need to think twice about tax, NICs or HMRC compliance. What arrives in your bank account is yours to keep, and you don't need to keep any aside for tax payments at a later date. But, the amount of take-home pay you get will be lower than that of a limited company contractor, as you'll be taxed on your full income. There's very little room for claiming expenses as a way to reduce your taxable income. You'll also need to cover the umbrella company fees for their services.
Limited Company Take-Home Pay
When you're contracting through a limited company, you'll usually benefit from higher take-home pay. This is because you can pay yourself a combination of salary and dividends - whereas contractors working with an umbrella company are limited to being paid a salary, with dividends not being an option - and there's a lower tax rate on dividends, reducing your tax bill. In the UK, the income tax rate on earnings over £12,570 is 20% for basic rate taxpayers, rising to 40% for those earnings above £50,271. But, dividends are taxed at a rate of 8.75% for basic rate taxpayers and 33.75% for higher rate taxpayers. By having some of your income being paid as dividends, the amount of tax you have to pay is reduced.
Contracting through a limited company also comes with the benefit of being able to claim expenses - such as travel, equipment and training - on things that you've bought for business purposes. This is rarely an option when you're paid through the PAYE system by an umbrella company, as you're considered an employee for tax purposes
The Other Benefits of Choosing a Limited Company vs. Umbrella Company
There's no denying the financial, take-home pay and tax advantages of choosing to contract through a limited company, but the benefits don't stop there. There are several other benefits that make this option appealing to contractors, regardless of industry, sector or niche.
- Professionalism - Contracting as a limited company can boost your professional credibility and, with many clients and businesses often viewing limited companies as being more established and reliable, this can help you secure more lucrative contracts.
- Separate Legal Entity - When you set up a limited company, you are a separate legal entity from the business. This means the company can own assets, enter into contracts and go into debt, without your personal assets being at risk. It provides an added layer of protection, as your savings, properties and assets are safe if the business faces financial difficulties.
- More Control - As the director of your limited company, you have full control over its operations. This gives you the ability to make decisions that align with your business goals and priorities, without being restricted by umbrella company policies or processes. You don't have to factor in anyone's way of doing things, as you're in control.
- Tailored Business Operations - With a limited company, you can tailor the day-to-day running of the business to suit your specific needs, including hiring employees or subcontractors if you want to. You'll also have the freedom to expand your services or break into new markets, in a way that works for you. This flexibility is rarely available when working through an umbrella company, as you're somewhat limited by the way the umbrella company does things.
- Ownership of Intellectual Property - A limited company can own intellectual property such as patents, trademarks or copyrighted material. This is beneficial if you're a contractor in a creative or technical industry, where protecting and using intellectual assets is important. This isn't always the case when you're working under an umbrella company.
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FAQs
What is the difference between an umbrella company and a limited company?
An umbrella company employs contractors and handles their payroll, taxes, and administrative duties. In contrast, a limited company is an independent business structure where the contractor operates as a director, managing their own finances and business responsibilities.
Which option provides a higher take-home pay?
Typically, operating through a limited company can offer a higher take-home pay due to the ability to structure income tax-efficiently, such as through dividends. However, this comes with greater administrative responsibilities compared to an umbrella company, where taxes are deducted at source under PAYE (Pay As You Earn).
How is tax handled in each option?
With an umbrella company, taxes and National Insurance contributions (NICs) are deducted before the contractor receives their pay. In a limited company, the contractor is responsible for managing their own tax obligations, including Corporation Tax, VAT (if applicable), and personal tax through self-assessment.
What are the key deductions affecting take-home pay in an umbrella company?
Deductions include Income Tax (PAYE), Employee's National Insurance, Employer's National Insurance, the Apprenticeship Levy, and any applicable umbrella company fees.
Are there any tax advantages of using a limited company?
Yes, a limited company allows for tax planning strategies such as paying yourself a lower salary and taking dividends, which are taxed at a lower rate compared to PAYE income.
Is IR35 legislation relevant to take-home pay comparisons?
Yes, IR35 impacts limited company contractors working within the scope of the legislation, as they are required to pay taxes similar to employees. Contractors outside IR35 can benefit from greater tax efficiency.
What are the typical take-home pay percentages for each option?
For an umbrella company, take-home pay usually ranges between 60-70% of the contract rate after deductions. With a limited company (outside IR35), contractors may take home around 75-85%, depending on tax efficiency and expenses.
What are the administrative responsibilities in each option?
Umbrella companies handle all administrative tasks, including payroll and compliance. Limited company contractors must manage bookkeeping, tax filings, and compliance with Companies House and HMRC regulations.
Can expenses be claimed under both structures?
Limited company contractors can claim a wider range of allowable business expenses, such as travel, equipment, and professional development. Umbrella company contractors have limited expense claims, especially post-IR35 reforms.
Which option offers more financial flexibility?
A limited company provides greater financial flexibility and control over how income is received and taxed. An umbrella company offers convenience but less flexibility in financial structuring.
Are there industry preferences for one option over the other?
Certain industries, particularly those with short-term contracts or high IR35 risk, may favour umbrella companies for compliance simplicity. Others, such as IT and engineering, may benefit more from the tax efficiency of a limited company.
How do contract rates affect take-home pay calculations?
Contractors with higher day rates may find a limited company more beneficial due to the potential for greater tax savings, while those on lower rates may prefer the simplicity of an umbrella company.
What are the implications of switching between the two options?
Switching from an umbrella to a limited company (or vice versa) requires careful planning to avoid tax complications and ensure compliance with HMRC regulations.
How do pension contributions differ between the two?
Under an umbrella company, pension contributions can be deducted before tax, while a limited company allows for employer pension contributions as a tax-efficient expense.
What income level justifies setting up a limited company?
Generally, contractors earning £30,000 to £40,000 per year or more may find it financially beneficial to set up a limited company, as the tax savings and flexibility can outweigh the administrative burden.
How should I choose between an umbrella company and a limited company?
The decision should be based on factors such as contract length, IR35 status, desired level of control, administrative capacity, and financial goals. Consulting with an accountant or financial adviser can provide tailored guidance.
At Go Limited, we regularly deal with contractors who want to know how take-home pay differs between umbrella companies and limited companies, and you can see that the difference is significant. Your take-home pay is likely to be higher if you set up a limited company, which is why it's something that a lot of contractors do. Though a limited company does come with slightly more work in terms of admin, accounting and managing expenses, the reward is having a higher take-home pay and maximising your earnings.
