If you are new to freelancing and just researching umbrella companies, you may wonder why a margin is deducted from your pay. After all, you are an employee. Yes, that’s true, but an umbrella company is not a traditional employer in that sense. Let us explain.

Why is there a cost to using an umbrella company?

Contrary to a traditional employer, umbrella companies provide a service. You don’t work for them, but they work for you and organise your freelance income into a PAYE pay package. The most practical and efficient way to do that is to take you on as an employee.

Let’s see what that involves:

• Organising your income/taking over the admin burden – imagine the administrative burden of being self-employed, looking after invoicing, chasing non-paying clients, claiming expenses, etc. – all that is taken care of when you are working through an umbrella company.

• Pay your taxes over – When you run your own freelance business, you have to remember to pay the correct tax and NI and submit a self-assessment return on time every year. Your umbrella employer takes all of this off your shoulders, making the necessary deductions and paying all your taxes over.

• Providing benefits – The margin deducted goes towards providing a range of benefits that makes the umbrella trading vehicle attractive:

• Compliance – an accredited umbrella provider will be compliant, ensuring that your taxes are paid according to HMRC’s rules.

• Pension – like all employers, umbrella companies will sign you up for auto-enrolment per government guidance; many will offer other arrangements like salary sacrifice.

• Insurance – almost all umbrella firms will provide professional cover, so you don’t have to pay for a policy yourself. This alone can save you hundreds of pounds per year.

• Online portal – established firms will have a client portal where timesheets and expenses can be submitted; it will also hold all your contract documents, so everything is in one place.

• Discounts – through affiliations and partnerships, most companies offer discounts on personal tax services, mortgage, investment and pension advice; some will even offer employee discounts on shopping.

• Advice – years of experience help umbrella companies help you. They can advise on IR35 issues or choose the best trading vehicle for tax efficiency.

• Statutory benefits – maternity/paternity, sick pay, and holiday pay are all there like they would be with any other employment.

The typical cost you can expect to see

Umbrella margin – Umbrella fees are called “margin”, and these are a fixed amount per week or month. Typically, they are between £15 and £25 per week. Ideally, this should be the only factor differentiating one quote from another when shopping around; every other deduction (NI and tax) is a standard rate dictated by HMRC rules.

You may see companies quoting percentage margins on your invoices, which may look attractive if you have less work, but you may be handing over more of your earnings once things pick up.

Other deductions – Like with any employment, you can expect to see income tax and Employee National Insurance deducted from your pay as well.

If you are a basic rate taxpayer (total earnings below £50,270 per annum), you’ll pay tax and National Insurance on your earnings over the annual personal tax allowance (£12,570). From January 6 2024, this means 20% tax and 10% National insurance. Anything earned over £50,270 will be charged 2% NI and income tax of 40 and 45%.

It is important to note here that the Employer’s National Insurance of 13.8% will also be deducted from your gross pay. This is unique to umbrella companies as their fee does not cover the cost. On the flip side, this allows them to minimise their processing fees.

Deductions are shown on the payslip. Click here for a handy guide that explains what’s on a SmartWork payslip.

How do you pay for an umbrella company’s services?

The umbrella margin gets deducted from the assignment rate the umbrella company receives for the contractor’s services and is deducted before taxes, meaning that there is tax relief on the margin itself. Take-home pay illustrations often show the net amount, not only to show the real cost but to save you the hassle of working it out.

For example, if you earn £3,000 a month, a £100 umbrella margin would leave you with £2,900 to be taxed. The savings made on the £100 not being taxed is a little over £30, so you only pay £70 or so for the umbrella service in reality.

What other costs should you look out for?

Thankfully, accredited companies are fully transparent, so there should be no surprises if you go with an FCSA (Freelancer and Contractor Services Association) accredited provider. If you choose one that isn’t, look out for the following:

• Joining or exit fees
• Admin fees for processing your records (timesheets, expenses)
• Fee for same-day payments
• Insurance costs (if not included)

We’ve talked about hidden fees and other factors you should consider when shopping around for an umbrella company in an earlier article of ours here.

We hope you found this article useful. We have many more like these on the guidance page of our site here. If you’d like to see more helpful information in the future, please follow us on our LinkedIn, Facebook, and Twitter.

If you are looking for an accredited umbrella provider, please contact one of our business managers by calling 0800 434 6446 or e-mail info@smartwork.com.