Advantages and disadvantages of using an umbrella company

There are a number of pros and cons to consider if you’re contemplating joining an umbrella company. Here, we look at the main advantages and disadvantages of becoming an umbrella employee.

The advantages

Compliance

If you’re a contractor or freelancer, you will definitely want to be sure that you’re paying the correct amount of income tax and National Insurance Contributions (NICs). A compliant provider will do this.

No tie in

Umbrellas are beneficial because you do not need to commit to their services for an extended period of time. By registering with an umbrella company, you become an employee of theirs. However, for any weeks you’re not using the service – there are no additional fees.

Umbrella companies generate their income by deducting a margin from the gross pay of a temporary worker. Therefore, if you’re on the books of an umbrella company but have weeks where you don’t work – you won’t have the margin to worry about.

And, if you want to leave an umbrella, all you need to do is request a P45, and that’s it. There are no associated leaving fees, and you certainly shouldn’t face any joining fees either.

Minimal administration

Umbrella companies are designed to make your life as easy as possible. After you become an employee, all you need to do is submit signed timesheets on time to be paid.

The umbrella structure minimises your administrative responsibilities. Therefore, you could argue that using an umbrella is by far the easiest method to get paid from a contractor’s perspective.

Extras

As part of their service, umbrella companies will offer ‘extras’ to encourage people to choose them over the competition, for example;

• Same Day Faster Payments (FP)
• Extensive business insurance
• Employee discount schemes that will allow you to save money when shopping or eating out
• Access to a mobile app – another way to streamline the umbrella payroll process
• Referral rewards which allow you get earn margin-free weeks when you recommend the umbrella to a friend or colleague

Shop around and see what is on offer when you’re interested in using an umbrella. Firstly, make sure the umbrellas comply with HMRC and have a good reputation. Secondly, look and see what extras are included as part of their standard service. You may be surprised by what is on offer.

Employee rights

By registering with an umbrella company, you are becoming an employee, and the umbrella is your employer. Therefore, you are entitled to employee benefits, including statutory sick pay and paternity/paternity pay.

The provision of employee benefits is one of the main advantages of using an umbrella company because it’s rare for contractors, freelancers, and agency workers to have access to these (as sole traders, or via a limited company).

Continuity of Employment

Continuity of Employment could prove invaluable to some umbrella company employees. But what is it? Historically, it’s always been more difficult for the self-employed to source external finance.

For example, getting a mortgage is generally more challenging for those not in permanent employment.

However, Continuity of Employment with an umbrella company changes this.

When you join an umbrella company, they become your employer. However, you do not need to switch umbrella companies when you change assignment – assuming you still want to use an umbrella for your payroll.

Therefore, you are free to work on multiple contracts whilst having the same employer.

In other words, using an umbrella company could help you get a mortgage, grow your credit rating or borrow funds from a bank because banks may lend favourably as you have a consistent employment history.

Signing up is easy

Like most administrative tasks, registering with an umbrella company isn’t particularly fun. However, it’s far easier than you may have imagined. When you’ve decided which umbrella you would like to use (make sure they’re compliant), give them a call and express your desire to register with them. The umbrella company’s sales consultant will run through the processes with you.

You will need to provide the umbrella with multiple pieces of information about you, including your full name, address, date of birth, National Insurance (NI) number, assignment details, bank information, and more. These pieces of information are required by law, and without them, the umbrella cannot process your payroll.

Once you have registered, you will be asked to read over the umbrella’s employment contract that you will need to sign and return. You’ll also need to send in a P45 or complete the New Starter Checklist (a government form available online).

It’s not as much hassle as you might have imagined, and as we explained earlier, there isn’t much administration involved after that.

Switching umbrella companies is straightforward

If you are using an umbrella company and you’re not impressed with how they’re operating, you can switch umbrella companies easily. All you need to do is contact the umbrella, let them know you’re leaving, and ask for a P45.

In the meantime, identify an umbrella company you would like to switch to and give them a call. They’ll guide you through the processes involved, but essentially, it’ll be the same as when you registered with the umbrella company you are leaving.

One question that umbrella employees frequently ask is, “can you leave an umbrella company mid-assignment?” The answer is yes, and you shouldn’t remain on the books of an umbrella you are dissatisfied with.

Low margin and cheaper than an accountant

Most umbrella companies deduct a margin from the workers’ gross pay each time payments are processed. As most assignments run with a weekly or monthly payroll frequency, umbrellas tend to, unsurprisingly, offer two margins – a weekly margin and a monthly margin.

Margins will vary between providers. Usually, the best, most well-known umbrella companies in the UK will offer weekly margins between £15 and £25, or £60 and £100 per month. When you compare these figures to those of a contractor accountant, they’re far less. And, it’s worth remembering umbrella companies offer more than just payroll, such as insurance, etc.

Find out more in our article – the lowdown on umbrella company fees and margins.

One helpful piece of advice – don’t just focus on the margin as the reason to join an umbrella company or not. There are plenty of other factors that should be considered, including service, compliance, reviews, reputation, etc. What is the point in saving a few pounds each week if the service you receive is unacceptable and you are often paid incorrectly, or late?

Same umbrella for multiple assignments – makes life easier

We’ve mentioned Continuity of Employment, but we didn’t focus on how convenient it is to use the same umbrella for all your temporary assignments. If you’ve ever used agency PAYE (which has its advantages and disadvantages too), you may be used to switching from various payrolls regularly.

With an umbrella company, you can use the same one for all assignments, meaning the ongoing administration is minimal, and your life is made easy. It is, however, essential to ensure the supply chain is up to date with your circumstances – to ensure your funds can be efficiently sent down the chain and paid into your bank account on time.

IR35 isn’t a consideration because you’ll be paid as an employee

If you’re a seasoned contractor, you will know all about IR35 and the associated complications. It’s no secret that operating through a personal service company (PSC) while outside IR35 is the most tax-efficient way to work as a contractor. Therefore, if you use an umbrella company, you’ll be paid with PAYE, which means less pay retention.

However, if you find yourself inside IR35, umbrella companies are convenient. Sure, your pay retention won’t be the same as operating outside IR35 through a PSC, but umbrella companies exist to ensure you pay the correct legal tax to HMRC. Therefore, if you use an umbrella company, your tax affairs will be in order, and you won’t need to worry about an HMRC tax investigation in the future. And, as we mentioned earlier, there is no tie in period with umbrella companies, meaning you’re free to leave as you please – perhaps to start a new, ‘outside IR35’ assignment?

Disadvantages

Umbrella companies also have many disadvantages that you need to consider before committing to one. We’ve summarised the most common ones below.

Not the most tax-efficient way to operate as a contractor

Mentioned briefly above, using an umbrella company is not the most tax-efficient method of payroll for contractors and freelancers – working on assignments outside IR35 with a PSC is.

Limited company workers are paid via a mixture of a small salary, plus dividends. No NICs are payable on dividends, which offers a tax saving compared to traditional employees. You also have more choice over when and how much you pay yourself, which provides a number of tax planning opportunities.

Frustratingly, since the introduction of off-payroll working rules in the public sector (2017) and the private sector (2021), more and more contractors are being pushed towards the direction of umbrella companies because they are finding themselves inside IR35.

However, for assignments that fall within IR35, you could argue that umbrella companies (and perhaps the ones with the most competitive margins) do offer the most cost-effective payroll solution. After all, working via a limited company has few benefits when inside IR35.

PAYE

PAYE is the HMRC tax system that full-time employees are paid with. Therefore, it’s no surprise that contractors dislike the idea of being paid with the same system because there are often fewer benefits of being self-employed. Unfortunately, this is reality, and to make things worse, umbrella employees will need to factor in the employment costs – explained below.

Employment costs can be confusing

Umbrella company employees have to pay employment costs – additional deductions that are made to the assignment rate. Initially, these sound awful, but it’s essential to understand what they are first and realise that most responsible recruitment agencies/end-hirers take these into account when setting the assignment rate.

By joining an umbrella, you become an employee. Therefore, on your payslips, you’ll see the traditional PAYE deductions listed, including income tax, NI, etc. However, you will also notice that employment costs are deducted too – the Apprenticeship Levy (0.5%) and Employer’s NI (13.8%). Why are umbrella employees responsible for these?

Umbrella companies do not benefit from the work you undertake, and they exist purely for payroll purposes. Therefore, they cannot afford to cover the employment costs because the only income they generate is the margin they deduct each time workers are paid.

Nowadays, most up to speed recruitment agencies offer two rates for temporary assignments – a standard PAYE rate (probably for in-house agency PAYE payroll) and an uplifted rate should the worker require an umbrella company. The uplifted rate is designed to consider the employment costs and stop these impacting the worker’s pay retention.

The employment costs are not straightforward. While they’re not the fault of the umbrella company, the concept may take time to get used to. If you have any questions about your rate of pay and the employment costs, speak directly with your recruitment agency or end-hirer.

You become part of a chain and some elements fall out of your hands

Once you’ve joined an umbrella, all you need to do is submit signed timesheets to be paid on time. However, this isn’t strictly true. 99% of the time, the process will go smoothly, and you’ll be paid on time. However, if any errors or delays occur throughout the supply chain – you could suffer.

For example, if there is a technical error at your recruitment agency, perhaps a systems outage, they may be late paying your umbrella company. As a result, your umbrella company may not pay you on time.

You must work through an agency you trust and select a decent umbrella to take care of your payroll. Some umbrella companies will pay advances if such scenarios occur, so contact your umbrella and recruitment agency at your earliest convenience if you ever notice you haven’t been paid.

Picking a compliant umbrella isn’t as easy as it should be

It shouldn’t be difficult to choose a compliant umbrella. Still, sadly, it’s becoming more of a challenge because plenty of tax avoidance schemes and disguised remuneration agreements are entering the marketplace.

For example, during the coronavirus pandemic, a new type of tax avoidance was unveiled – mini umbrella companies. To summarise, these mini umbrella companies were paying temporary workers against their knowledge, and greedy recruitment consultants profited by making unethical referrals.

There have also been cases where so-called “compliant” umbrella companies were accused of retaining the accrued holiday pay of their workers – something that is illegal and immoral. Ultimately, you must choose a compliant, trustworthy, and ethical payroll provider to ensure you pay the correct tax and NI and avoid any penalties from HMRC.

With so many unethical providers promising inflated pay retention, it can be tricky to know whether or not to trust a particular company. Our recommendation is to pick an umbrella accredited by either the FCSA or Professional Passport.

These two bodies are self-regulating the umbrella company and contractor payroll sector and make it their priority to ensure payroll providers are compliant with UK tax law. If you’re looking for an umbrella, look at our directory of firms – including which ones are accredited by these two bodies.

Umbrellas are not regulated by the government

Although the FCSA and Professional Passport promote compliance, but there is no hiding from the fact that the government doesn’t regulate the umbrella company marketplace. The government does acknowledge umbrella companies, but it’s clear they have been reluctant to get involved with them directly – but things look set to change.

Throughout 2021, the government released several pieces of guidance to help temporary workers and supply chain members understand how umbrellas should operate and how to identify tax avoidance. They also launched a call for evidence that requests input from all stakeholders within the sector. The government appears to be slowly heading towards regulating the umbrella company sector. However, as things stand, there are no regulations in place. It’s common knowledge that some interested third parties refer to the umbrella company sector as the “wild west”.

You won’t have much control over your finances

When running a limited company, you have maximum control over your finances and will have a very active part in managing your business – even if you use the services of a contractor accountant to assist you. The opposite applies when you are an umbrella company employee. You are paid like a permanent employee, meaning you will receive your net salary after all deductions have been made – supported with a payslip. It’s easy, but it’s not ideal for those who like a hands-on approach to being a contractor or freelancer.

Claiming expenses is almost impossible

Before 2016, many umbrella company employees could claim tax relief on travel and subsistence expenses, which was one of the main reasons contractors were happy to use an umbrella when inside IR35. However, the government decided that most of the umbrella company employees claiming tax relief were working on roles almost identical to those in permanent employment. These people couldn’t claim tax relief on travel and subsistence expenses. As a result, the government stopped this by introducing legislation called Supervision, Direction and Control (SDC).

If an umbrella company employee is subjected to SDC within their workplace, they cannot claim tax relief on travel and subsistence expenses. In reality, almost every umbrella worker is subjected to SDC in one way or another, so claiming expenses through an umbrella company is now almost impossible.

A few exceptions apply, and umbrella employees can claim reimbursed expenses – if the agency or end client agree to these. However, they’re not anything worth getting overly excited about. These are the same types of expenses that full-time workers can claim, for example, a train fare for a trip associated with their job.

The sector isn’t in a great place at the moment

There is a dark cloud forming over the umbrella company marketplace at the moment, and it’s getting worse. Compliant umbrella companies provide a valuable service for temporary workers, but the market is being tainted by multiple malpractice cases, unethical behaviour and, unfortunately, cyber-attacks. If the government is going to regulate umbrella companies, hopefully, it happens sooner rather than later – to restore people’s faith in the payroll providers.

Further reading

Try these popular guides for more useful tips and advice:

• Limited vs Umbrella company – which is the best structure?
• How to compare umbrella companies – 15 tips
• Umbrella company fees – how much should you expect to pay?
• How to find genuine and useful umbrella company reviews