Umbrella companies: The pros and cons when you’re self employed

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Umbrella companies are often mentioned in the context of self employed workers like freelancers and contractors, but what they actually do and how they work is often a bit of a mystery to the uninitiated.

Part of the confusion comes down to the fact that there is no legal definition for these types of companies, so how they operate can and do vary.

Even HMRC’s definition of these entities is a bit loose: 

“It is generally agreed that an umbrella company is a company that employs a temporary worker (an agency worker or contractor), often on behalf of an employment agency. The agency will then provide the services of the worker to their clients.”

With this in mind, I spoke to Joanne Harris from Optionis, which counts an umbrella company as part of its business, about when this arrangement might suit you.

What is an umbrella company?

As mentioned above, there is no clear definition of an umbrella company so the nuances of how they work are all written in the contract between the company and the worker.

What underpins this arrangement is that the umbrella company is legally your employer, albeit in a purely administrative sense.

So your salary is paid out under the PAYE system, and they’ll calculate your taxes, National Insurance Contribution, holiday (minimum of 28 days) and statutory sick pay, and any allowable expenses for you.

They’ll also charge a fee for their services, generally known as the margin, and this is taken off before they pay you. This can be a set fee or a percentage of your income.

However, the onus is on you to find jobs, and you can choose where, when, and for whom you work for.

Is using an umbrella company the same as being employed?

In a word, yes – if it’s a tax compliant umbrella company.

Harris said: “Any compliant umbrella company will employ you. You are an employee and with that you get statutory employment rights. So you get statutory sick pay, statutory maternity pay etc.

“But you’re in control of the assignments that you take.”

When might you need an umbrella company?

The main reason for going through an umbrella company is that it’ll allow you to take on work that you wouldn’t be able to otherwise, according to Harris.

Some companies or recruitment agencies might not want to work with sole traders for example – the reasons for this are discussed in the Focus on self employment vs limited company – so umbrella companies allow you to work through a limited company without having to set up your own.

Harris explained: “If you’re operating as a sole trader and the majority of your clients are happy with that, but then you get offered a short term assignment, perhaps via a recruitment agency, you are unlikely to want to incorporate a limited company purely for this one assignment.”

Some umbrella companies will allow you to sign on just for one contract and then leave when that’s finished.

On the flipside, there may also be circumstances where you may not be able to work through your limited company due to IR35 rules – again, an umbrella company can help you overcome that hurdle.

What are some of the pros of an umbrella company?

Aside from allowing you to take on jobs that you wouldn’t be able to otherwise, the key benefit is the amount of admin it should save you.

“You submit a timesheet and you get paid,” says Harris. “Really, really easy.”

She added: “The fact that you get employment rights and protections is quite significant, particularly if you’re a sole trader.”

You also benefit from being in continuous employment – you just take on different assignments through the umbrella company, rather than starting separate contracts – which can help when it comes to getting a mortgage.

Some umbrella companies will offer additional benefits, such as health insurance, as well.

What are some of the cons of an umbrella company?

Despite the fact that you’re an employee when it comes to tax, there is one crucial difference: Just like self employment, there’s no fixed pay day.

Instead, you’ll get paid when the umbrella company gets paid, although this tends to happen pretty quickly after you submit your timesheet.

But the big downside of umbrella companies is that they’re not as tax efficient as being self employed or a limited company.

Many of the expenses that would be allowable under self employment or available to a limited company are not for someone working through an umbrella company.

And because they charge a fee, you may find that the day rate you would normally get isn’t as high.

That’s why it’s important to check the details of your contract, and ask for a key information document, which will show you how much you’ll actually get paid after all the fees and taxes.

It’s also important to bear in mind that if the umbrella company goes bust before you get paid, it’s unlikely you’ll ever see that money again.

How do you go about choosing one?

Umbrella companies are completely unregulated at the moment, so you’ll need to do some due diligence before signing up to one. 

Any umbrella company that claims to be able to save you lots of tax is a major red flag for Harris – you shouldn’t be getting any tax benefits by offering your services through an umbrella company.

As you’re an employee, you should expect to be paying the same amount of tax as an employee of any other company on the same salary in the same circumstances.

When it comes to selection, Harris suggests looking at companies accredited by the Freelancer & Contractor Services Association (FCSA) or Professional Passport as a starting point, but reviews websites like Trustpilot can also be important, too.

Can you switch from one umbrella company to another?

Yes, it works in the same way as leaving one company to join another.

Harris explained: “You would need a P45 from your first employer and provide this to the new umbrella employer. 

“As with any employment, you will need to pass right to work checks and provide your personal information. 

“It isn’t particularly complicated, and often happens as many recruitment agencies will have preferred supplier lists so they can ensure the compliance of the umbrella companies that they work with.” 

She added: “Of course it would usually be better for the employee to stay with one umbrella employer to maintain continuity of employment.”