How does an umbrella company work?

Contractors can operate under their own limited company through a PAYE agency or umbrella company. Both options have different consequences for the contractor’s tax liability, for how they are able to work, and for the benefits they receive.

In this Compare Your Pay guide to Umbrella Companies, we hope you find a helpful explanation how an umbrella company works. Whether you’re a contractor considering this option or just want to learn more, we’ve broken down everything there is to know about umbrella companies so you can decide if it’s the right choice for you. 

What is an umbrella company?

An umbrella company is a recruitment agency that works between the contractor and the client. As such, it will employ the contractor, who in turn will be paid by the umbrella company and will be entitled to a set of benefits that he would not have received if he was a limited company contractor. 

The contractor agrees what contracts to take on, but the umbrella company retrieves the contractor’s earnings from the client and processes them, paying the correct levels of tax and National Insurance.

In fact, this is an advantage of umbrella companies in the eyes of many contractors, who do not have to worry about the complexities of tax calculations by filling in a self-assessment form.

Aside from making contractors’ working lives easier when it comes to paying for their services and paying the appropriate tax, there is a whole host of other perks offered by umbrella companies. 

What are the benefits of working through an umbrella company?

This is another benefit of using an umbrella company: for those contractors who want to avoid the headaches of setting up their own business, contracting has never been simpler. 

A limited company contractor, on the other hand, has the additional headaches of having to secure the contract work in the first place, as well as all the paperwork and admin of running a limited company, invoicing the client, chasing late payments, completing and filing a self-assessment, and putting aside enough money to pay the tax bill at the end of the year.

On the other hand, these tasks are all handled on the contractor’s behalf by the umbrella company – the latter takes care of processing tax and National Insurance, pays the contractor’s salary, invoices the client and takes care of the business admin.

It is simply a matter of the umbrella contractor emailing or uploading a timesheet, and the umbrella company taking care of the rest. This is why many contractors see working via an umbrella company as a fuss-free way of contracting.

This allows the contractor to have the freedom of the contracting lifestyle without having to deal with the hassles of running a business.

Another benefit of working through an umbrella company is that umbrella contractors are paid by PAYE.

An umbrella company will take care of this by paying the contractor via the PAYE system, which is the most common means of paying tax in the UK. 

This means that the contractor doesn’t have to fill in a tax return form for self-assessment, which is a very time-consuming task.

The umbrella company contractor also enjoys the advantage of the benefits provided by the umbrella company. The contractor is automatically made an employee of their umbrella company provider, and as such is entitled to statutory benefits including sick pay and holiday pay, a workplace pension, and maternity and paternity pay.

This is unlike being a limited company contractor, who has to pay out of their own pocket if they want to take a holiday or if they suddenly take ill.

The majority of umbrella companies also provide contractors with basic levels of insurance; they don’t need to work out and pay for these themselves.

Later on we focus on the benefits of working through an umbrella company, which will probably explain why thousands of contractors do so every year.

But what is an umbrella company exactly and how does an umbrella company work?

While contractors generate the income through their work-seeking efforts, they are paid via the umbrella company, which employs them.

The contractor will sign a contract with the umbrella company, after which, all they need to do is submit their timesheet each week, telling the umbrella company how many hours they’ve worked and what expenses they want to claim.

The umbrella company then invoices in the name of the contractor, collects the fee directly from the client, submits the correct tax and National Insurance contributions via the PAYE system, and pays the contractor the correct salary.

In return for the service provided and additional benefits offered to the contractor, every umbrella company will charge a fee. This fee is deducted from your pay before it is processed for tax. Visit our guide to umbrella company fees to find out more about how much you can expect to pay.

Just as any other employee does, the umbrella company will then issue you with a payslip that will detail what you are taking home and how much you have paid in tax and National Insurance. 

This contrasts with the position of a limited company contractor, who is self-employed, thus having to make his own arrangements for pay, client relations, tax and National Insurance and insurance.

Conclusion

Having read our guide on how an umbrella company works, if you’ve decided that being on an umbrella company is the best way forward for your contracting career, why not use Compare Your Pay to find your perfect umbrella company provider. 

You don't have to spend hours surfing around the web and compare umbrella companies to find an umbrella company that works for you as our team can show you a list of the best suitable umbrella companies for you.

Just let us know your details and we will give you the top providers straight away. 

We clearly display to you what you will receive from each umbrella company, the services, benefits and pay. We also show you a payslip example from each umbrella company so that you can make the best decision for you.

Ready to give it a go for yourself today?