Contractors, with umbrella companies it’s all about the rate. Right? Wrong

Working via an umbrella company may not be everybody’s first choice, and for many contractors who should not be caught by the IR35 off-payroll working rules, it can become a bitter pill to swallow, writes Lucy Smith, founder of Clarity Umbrella.

Best umbrella doesn’t equal best take-home

In a market swamped with non-compliance and still a lack of government regulation, it can lead contractors down the route of looking for the “best take-home,” as they look to maximise their pay.

At its worst, this wage prioritisation can lead to another temptation -- listening to claims like “We are QC-Approved”, or also known to seal the deal when take-home looks giddily high, “We are HMRC-approved.”

The latter is definitely meaningless because HMRC doesn’t grant its approval in such a way, but the umbrella companies uttering this falsehood tend to offer take-home of sometimes over 80%. From a compliant umbrella company, such a high take-home is simply not feasible.

Buying in to a brolly on margin is also for the birds

At the other end of the spectrum, there are contractors buying in to a brolly based on the umbrella’s margin!

For the avoidance of doubt, let me say that running a compliant umbrella company is not ‘cheap.’ A smaller umbrella may be charging a little more to ensure that their standards are kept high and potentially to offer a more personalised service. By contrast, where margins are low for a smaller umbrella company, it could lead to concerns as to how the business is operating— how it is maintaining itself despite such low costs.

The numbers game(s)

It's true for all commercial outfits, but umbrella companies especially are very much a numbers-based business; the larger the business, the higher the number of contractors on the books, the better the economies of scale.

That said, signing up with a large brolly comes at the potential risk of becoming one of those “numbers.” To mitigate this risk, always give a big brolly a call to suss out their customer or personal service, while making sure you are comfortable with their style and offering.

You can’t square a circle

We know IR35 reform directly or indirectly landed thousands of PSC contractors in umbrellas. And if you used to work via your own limited company (also known as a Personal Service Company), then the take-home with an umbrella can look disappointing. There’s unfortunately no getting away from that income drop.

To once-PSC contractors with this gripe, we say revisit your contract’s headline rate wherever possible, considering negotiating it up, and then make a decision as to whether you can make it work.

To restate the obvious slightly differently, there is no simple or satisfying way of doing a like-for-like comparison between a limited company rate and an umbrella company rate.

Can you cover umbrella company employment costs?

But what you can look to do is to try and cover the Employment Costs that you are now seeing taken from that day rate; including the Employers NI, Apprenticeship Levy and the umbrella margin.

As a standard, you would need to look for around a 23% increase on the limited company rate to cover these costs.

For example, an outside IR35 rate of £600.00 per day would need an increase to £738.00 per day, inside IR35, to cover those employment costs.

Pensions are how umbrellas can make themselves more financially appealing to contractors

But also -- from the umbrella side, there may be a few things that can be done to help, and to that end, it may be worth considering paying into a pension.

Any contractor with a day rate of around £500.00 could fall into the dark hole of PAYE earnings between £100,000 and £125,000, at which point your tax-free allowance will start to diminish, making those taxes look even more swingeing!

At this point, it could be worth considering a pension sacrifice to take you back under the £100,000 and keep the £12,570 tax-free allowance that the normal tax code brings you.

For those contractors who are umbrella company employees but who have a limited company in the background, there also needs to be some careful consideration.

Got a PSC in the background? Remove yourself as your limited company’s employee

We strongly suggest removing yourself as a PAYE employee of the limited company.

Remember, you could still draw dividends, but removing yourself as an employee could help prevent any dual employment tax codes (‘BR’), that may leave you with a tax bill once you have finished the umbrella employment.

Further (taxing) considerations

You also need to be aware that any PAYE umbrella earnings will affect your dividend taxes due to HMRC, so consideration as to how much you want to earn through PAYE on the umbrella is also worth a moment.

Similarly consider -- keeping your umbrella earnings to under £50,000 for the year leaves any dividends taken from the limited company being taxed at 8.75%, keeping total earnings under £150,000 at a rate of 33.75%.

So again this is where the pension could come into play, helping you manage those earnings on both sides.

Final thoughts

Rather than falling for those tempting but ultimately self-defeating offers from umbrellas that are inevitably going to get you in trouble with HMRC, take a moment to rethink and if possible, renegotiate your rate before you decide whether to take that assignment. Or just carry on looking for something that’s viable. And do take another moment to consider whether saving for your retirement may make that move to umbrella a little more palatable.