What is an umbrella company and should I be using one?

There’s a lot to think about as a freelancer or contractor. Whether it’s seeking new clients, negotiating pay or networking - there’s never a dull moment.

Most freelancers and contractors will know that work can be intermittent. They aren’t employees of a company, so are either a limited company or self-employed.

It’s therefore up to the individual to separate their own income, which is usually paid as a lump sum free of any deductions. Tax will almost certainly need to be worked out, as will forward planning for a holiday, a baby, having cash reserved in case of illness or anything else that may come up in life.

An umbrella company can take on some of that burden though.

In fact, more than a third of successful businesses we surveyed* recently told us they use an umbrella company to manage their finances. 

But before we get into the pros and cons of using an umbrella company, let’s first establish what they are.

What is an umbrella company?

An umbrella company is effectively an employer. They are most often used by recruitment agencies to pay temporary workers. They’ll take care of paying wages through Pay As You Earn (PAYE), as well as sorting out contracts and holiday pay among other things.

Here’s an example of how it works in practice:

• A client needs the services of a freelancer or contractor on a temporary basis

• A recruitment agency advertises the work to its network of freelancers

• A freelancer/contractor secures the work

• The umbrella company, a separate business to both the client and the recruitment agency, becomes the employer for the work carried out by the freelancer

You may have a choice of umbrella companies, or you may need to choose one that already has a relationship with the recruitment agency.

Depending on the type of contract, you may not have a choice on whether you can use an umbrella company - something called off-payroll working is a consideration and will determine if the work is inside or outside of IR35.

It’s worth saying that using an umbrella company means you're taxed as an employee, so your IR35 status is no longer a worry.

But often you do have a choice whether to use one. So let’s look at the pros and cons.

Pros

Employment rights and benefits

Using an umbrella company means you have the same employment rights as other employees - this is because the umbrella company is your employer. You can find a full list of your employment rights on gov.uk, but entitlements include:

• Paid holidays - the length of your contract will determine your entitlement

• Being paid at least the National Minimum Wage

• Auto-enrolment to a workplace pension scheme 

• Statutory sick pay

If you are entirely self-employed and choose not to use an umbrella company, these rights are most likely not available to you.

If you choose to always use the same umbrella company, you also benefit from being able to evidence continuous employment too, even if you work for multiple clients and companies. This is because the umbrella company will remain your employer for any number of different contracts and clients. This makes mortgage and credit applications considerably more straightforward.

Tax compliance

Most umbrella companies will pay you in accordance with HMRC regulations and applicable UK tax law, just as any UK employer would do. This can help ease anxiety around tax and the potential for an investigation into your finances by HMRC, which can happen if you declare yourself as self-employed. 

It’s really important to check that the umbrella company you use is tax compliant. Some may promise things that seem too good to be true and may be involved in tax avoidance schemes. Checking the company out online or with the Financial Conduct Authority (FCA) can help reassure you. 

Less admin, no commitment 

As an umbrella company acts as an employer - much of the administration you might otherwise have to complete as a freelancer is removed. In fact, once the initial contract is all signed and sorted, you’ll usually only need to submit your timesheet and they’ll take care of the rest. 

You also don’t need to commit to any umbrella company for a specific period of time - meaning you can use their services for one full contract term or part of a contract’s term. Most umbrella companies build their margin into their payroll process, so you shouldn’t find you have to pay any joiner or leaver fees either. 

Cons

Less financial control

If you like to get into the details of your finances as a freelancer and you enjoy the practical management of it, an umbrella company might not be as attractive to you. All of your deductions will be made for you, and you’ll have no real say on what goes where.

As a result, an umbrella company option is not as tax efficient as some other options available when you work for yourself. This is particularly true for Directors of limited companies. A Director is typically paid both a salary and dividends through their limited company - this isn’t an option if you’re working for an umbrella company. Even contractors, so long as they’re outside IR35, will retain more of their money operating outside of an umbrella company. 

No expenses

Pretty much all freelancers and contractors that use an umbrella company are not able to claim for expenses - be it travel or otherwise. This came about in 2016 to stop umbrella company employees from claiming expenses on work that permanent employees doing the same work couldn’t claim for.

This can be a significant disadvantage for many self-employed people who enjoy the benefit of claiming expenses for the work they do.

It’s not free

Umbrella companies are businesses too, and they need to get paid. Typically their business model involves them taking a percentage of your weekly earnings, though it might also be a flat fee. The fee can range but it’s usually around £20-£30 per week.

The fee might be worth it for you though, particularly if you would otherwise use an accountant - as accountant fees can quickly add up. In any event it’s well worth looking at a few umbrella companies to ensure you aren’t paying more than you need to before making a decision. 

* We surveyed 522 small business owners in the UK with between 10 and 99 employees, on June 11 and 13, 2024.