Umbrella company vs limited company: what’s the difference?

A contractor must make many decisions in their careers, one key decision being whether to operate through an umbrella company or a limited company. 

Both options have advantages and drawbacks, and the decision you make will significantly impact your day-to-day life, so it's important to do your research to make the best decision for you. 

To help, Compare Your Pay have put together this handy guide outlining the key differences between limited company vs umbrella company. 

Option 1 – umbrella company

An umbrella company is an external provider that acts as the intermediary between the contractor and the client. 

If you choose this route, you will sign up with your chosen umbrella company, which will then become your employer. 

Although they are your employer, you still work on your chosen contracts with your chosen clients, meaning you benefit from the freedoms and flexibilities of contracting. However, the umbrella company will deal with the client, finances, admin and paperwork, which are also part and parcel of contracting. 

Instead of working directly with the client and being paid by them, the umbrella company will collect payment on your behalf and instead pay you a regular salary, deducting the tax and National Insurance you owe through the Pay-As-You-Earn tax system. 

Option 2 – limited company 

The other option is to work through a limited company. 

Here, the contractor must set up their own limited company, which they must register with Companies House. Once you have registered your limited company, you will legally become a company director. This comes with a set of duties and responsibilities laid out here. 

As well as adhering to company director duties, you will also be responsible for filing an annual confirmation statement, which keeps your company's records and information up to date, as well as taking care of your company's finances, which includes filing annual accounts and a corporation tax return, as well as VAT returns if you meet the minimum threshold. 

You will usually become employed by your company, too, which means you will also need to set up a company payroll, which you must report to HMRC. 

When contracting through a limited company, you will deal directly with the client and must invoice them for your work and chase any late payments. 

Umbrella vs limited company: which is best for me?

Now that you know the key differences between the limited company and umbrella company options, it's time to decide which is best for you.

As we have outlined, there are several key differences between both routes. How do these impact you as a contractor and your decision about which is the best route? 

Find out more

Finances

As we have touched on when working with an umbrella company, finances are straight forward, and there's little for the contractor to worry about. 

The client will be charged the agreed fee, and the umbrella company will be the one to collect this from them, meaning no stressing about potential late payments.

The umbrella company will then pay the contractor a salary, processing their pay through their company payroll. This ensures that the correct tax and National Insurance deductions are taken before the contractor is paid. This means the contractor is always up to date with their taxes and doesn’t need to worry about filing a tax return. 

If you choose to operate through a limited company, on the other hand, you must file a number of tax returns, including company accounts, corporation tax and usually a self assessment. This usually requires the help of an accountant which will set you back at around £2,000+ per year. 

Ease of use

An umbrella company takes on the administrative and paperwork tasks involved in working with a client. For example, they will process your expenses, deal with all elements of client relations, ensure your pension is sorted, and ensure you are set up on the payroll. 

This leaves the contractor little to do apart from get on with the contract at hand. 

When working through a limited company, however, the contractor must take on all these tasks themselves. In addition to running their own business and dealing with the admin that comes with this, they must also deal with client liaison, invoicing, expenses, and any other tasks that occur. 

Statutory rights

It is also worth considering that if you use an umbrella company, as an employee you become eligible for statutory rights. This includes paid holiday leave, sick leave and maternity or paternity leave. 

Contractors who work through a limited company are self-employed and, therefore, don't benefit from such rights. This means that if they become ill or even just want to take a well-earned break, they won't be paid for their time. 

IR35

Another consideration for all contractors is IR35. After all, no contractor wants to get caught out. 

The great news is that if you decide to sign up with an umbrella company then you are automatically exempt from IR35, meaning no stress about whether you are inside or outside. 

However, the same can’t be said for limited company contractors, who must take the time to ensure they are compliant and don’t get caught out which can lead to expensive, stressful and timely investigations. 

Ready to go umbrella?

After reading our guide to umbrella company vs limited company, if you have decided that an umbrella company offers the most hassle-free option then we can help you find the best umbrella company out there for you. 

After all, this is a great option to help free up more contractors' time and energy and leave the admin and paperwork to someone else. However, you will need to ensure that you choose an umbrella company that’s the perfect fit for your contracting needs. 

That's where Compare Your Pay can help. We will work closely with you to find the best match. Simply get in touch today and take the next steps.