Umbrella vs Limited comparison
So you decided to enter the freelance market and become a contractor? But of course starting off is so full of uncertainty and potential risk that you looked for the simple and easy route to entering the market – an Umbrella solution.
Naturally, back then it seemed like the right thing to do. After all, you gain many of the freedoms of being a freelance worker without any of the long-term commitments. And making the most financially out of the decision was perhaps lower down your list of priorities.
But as time progresses, you may begin to think and ask whether your working solution truly reflects the high degree of professionalism with which you provide your skills. And are you making the most of all the opportunities available to you as a contractor?
Being in business is a challenge – there’s no denying that. And the challenge is not for everyone. So why complicate your life with running your own business? Is it all about money or is there simply a better way to fulfil your original objectives?
No doubt part of the decision making process when moving to contracting was about the money … finally being paid what you’re really worth. Having choice and that feeling of freedom, gaining a wider experience in different working environments and being able to take chunks of time off when it suits you are also arguments we have heard for making that leap into the unknown.
But eventually we all ask ourselves … are we doing the right thing, and are we doing it the right way?
So, what are the alternatives … and where can you get a truly unbiased view of the pros and cons of each?
Well, we at Intouch are providers of Limited Company solutions, so we obviously have a vested interest in explaining just why you should make the switch to running your own business. But that’s not what we’re here to do…
We agree that being an Umbrella can be the sensible option if it feels right, if you’re happy with the solution and you feel you’re going to get the most from how you operate. But let’s explain the differences between being Limited and being an Umbrella in a straight-forward, honest way … the “warts and all” … and leave you to answer that key question yourself … am I doing the right thing, in the right way?
Umbrella vs Limited – the “low down”
One of the main advantages of an Umbrella is its simplicity. You get a contract, refer to your Umbrella company, and it’s all systems go. All you need to do is record your time, record your expenses and … hey presto … you get paid. You don’t even have to worry about tax – it’s all dealt with for you. Hey, take the money and run, why not?
But is the choice really that simple?
We like to think that there are contractors out there who are concerned about getting the most from their efforts. After all, whether you are working through an Umbrella or through a company, your day-to-day work is exactly the same … you go to the client, you work, you hope to get paid.
But what if you could get paid MORE…?
Well the answer depends on whether you judge your income level by the rate you charge or the amount you take home to spend. The simple answer is that whether or not you are subject to IR35 you can take home more money for the same effort than you can from an Umbrella.
So making the switch from an Umbrella to your own company is a bit like an immediate uplift in pay. Although unfortunately there is a price – admin! But is the price really that much? And who can honestly say they don’t want a pay rise?
Let’s take a look at an example …
To get us going, let’s make some assumptions…
You work 35 hours a week for £40 an hour. You work 45 weeks a year. Whether you are an Umbrella worker or a Limited Company contractor your income is the same – £63,000.
You claim the same travelling and subsistence expenses whether you work via an Umbrella or a company; let’s say £100 a week, so that’s £4,500.
You want to pay some pension, say £200 a month; and a bit of sickness cover, say £45 a month, so those cost you £2,940. Basically no difference whether you’re an Umbrella or a company either!
You pay an Umbrella £25 a week plus VAT, but only when you work, we’ll use Intouch’s monthly fee here of £85 per month plus VAT. So we have a slight difference here.
An Umbrella is costing you £1,350 and Intouch costs you £1,224. But hang on … is that right? How can an accountant cost less than an Umbrella? Ok let’s reduce the weekly fee for the umbrella to £20 a week plus VAT – that’s £1,080 (hope you don’t pay more!)
Ok are there any other differences in the numbers we are going to work with? Yes, there are many costs you can claim against tax as a company you can’t usually claim through an Umbrella, what about:
- The computer you use when working at home needed replacing, now that costs £800 including the printer, and the running costs and a bit of legitimate software are about £400 a year
- The mobile phone, which you can put in the company name, let’s say £480 a year
- Maybe some use of home as an office, let’s say £156, plus some of your home phone, say £80, it’s not a real cost but you can have some tax deducted anyway
- Your subscriptions to a professional body, and a couple of techie magazines, that’s £240 a year
- That all important staff party for you and your wife, that’s £300
- Life insurance, got to be careful here, but there are some clever products that can be paid by the company without taxes being charged, that’s another £480
So there are some extra costs here that a company could incur – or rather get tax relief for – totalling £2,916. It could be more, but our experience says its around that figure.
We forgot the spouse … they don’t go out to work, but they do help out with some admin, so the company should pay them. And of course they are a director too, so let’s pay them £600 a month. That’s a good level; it absorbs tax-free pay and incurs no National Insurance (NI). So no tax to pay – just a bit more legal tax relief.
Then your spouse also holds some shares. But we’ve been a bit clever here and thought about tax when we created your company, so your spouse holds “B” shares and you hold “A” shares. We’ll see why later.
But what about you? Well, you should be paid at least national minimum wage for your hard efforts, so you’ll get £12,000 a year. That incurs a bit of NI and some PAYE and some employers NI of £622. But we’ll take that into account later.
Lastly, there’s VAT. We’ll adopt the flat rate as you can make a profit on flat rate. We’ll explain more later on but, on a typical flat rate of 14.5%, which is pretty typical for contractors, you’ll make about £1,638 each year.
Well we’re pretty much finished, so let’s draw up the comparison:
Flat rate profit
Pension and insurance
Other expense claims
So a Limited Company worker earning the same amount, with the same real expenses (don’t forget the other expenses claims are not really additional costs, just a bit more tax relief being claimed), pays an gobsmacking £10,973 less tax than an Umbrella worker, but pays slightly different fees which are negligible and could go either way in reality.
So just how much admin is worth a pay rise net of tax of over £10,000 a year? Well let’s now think of the downsides …
How hard is running a company? Well that depends on who’s there to help you.
Ok, you have to record your time. Well that’s the same as an Umbrella … and most agencies self bill, so you don’t even need to worry about raising an invoice. Not much change there.
You have to record your expenses. Sound familiar?
So what else is there that makes running a company so hard?
Well let’s list each task and look at what’s involved:
– You have to form a company. Ok there’s plenty of help out there and yes it can cost you from £35 up to a few hundred.
Probably worth spending a bit more than the basic formation fee at companies house to get the right shareholdings in place so you can plan your income and taxation. But once it’s done then that’s it.
– Oh except you need to complete accounts and send them into Companies House and then there’s something called an Annual Return and a filing fee of £14. But there again isn’t that what your accountant will do.
– The company has to run its own payroll and pay you a salary, pay HMRC taxes and all that’s pretty complicated stuff. Ok, but isn’t that what your accountant does for you, all you need to do is pay yourself, and well that’s simple enough to automate via electronic banking if your accountant gives you the amounts upfront.
So all you really need to do is agree what salary you going to take and leave it to your accountant to run your payroll, and set up payments to your private account.
– But what about the end of PAYE year returns, oh the accountants do that too. Well VAT is not easy – everyone says how bad the VAT man is. But what’s this about the flat rate scheme, and what do you mean you can make money from it. The flat rate scheme was introduced to make VAT simpler for small businesses. You charge your clients VAT, but don’t worry so does your Umbrella, but instead of paying over the full 20% added to your invoice you only pay over, typically 14.5%. In the example above the profit is £1,638 per year. Ok you can’t claim back VAT on your expenses, but let’s face it most Umbrellas don’t give you your VAT back on your expenses, even though they often claim the VAT on your expenses to reduce the VAT they pay and so enhance their fees.
– But you have to do VAT Returns, oh, no, sorry your accountant has to do your VAT Returns, well they need to earn their fee somehow…but you still have to pay the VAT collected. Well you would if you couldn’t pay by direct debit following the online submission done by your accountant.
But then we get to the hard bit… The company bank account, well that’s a lot of hassle.
After all you have to pay yourself your wages – but didn’t we just agree that could be done by standing order, your expenses, ok that varies so a monthly transfer is probably the worst that can be, then 4 direct debits to HMRC for VAT and 4 payments to HMRC for PAYE and 1 cheque to HMRC for corporation tax. But you do need to keep accounting records.
– Well, that needs to be nothing more than downloading a bank statement electronically and importing into our accounting system.
And what about Corporation Tax and company tax returns?
– Ok, so the accountants do those too…..
So ask yourself … why is it so complicated to run your own business as a company?
Mmmmm, we’re not sure really. Maybe you should ask an Umbrella provider to remind you of why it’s so much easier to be Umbrella. And, even if they convince you that running a company is so very hard, ask yourself honestly:
Is it not worth it for a £10,000 pay rise…?
This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.