Contracting isn’t just a short-term fad. It’s a growing, thriving industry that for many, offers substantial financial benefits, greater control over one’s career and improved freedom and flexibility.
On average, contractors take home £5,414 more than their employee counterparts. Contractors charge higher rates, pay less in tax and can deduct expenses. In fact, whilst the average IT employee in the UK earns an average of £45,000, 2 out of every 5 IT contractors earn a hefty £500 per day. That is a salary equivalent to £130,000.
When it comes to making the leap from permanent employment to contracting, take home pay is likely a big factor in the decision-making process.
A contractor’s income will be dependent on decisions such as whether they work through an umbrella company or a limited company. There are also factors to account for such as IR35, expenses and tax that all affect income.
So, how can a contractor find out how much they will earn depending on these variables and under new IR35 rules that will roll out in 2020?
Contractor experts Umbrella Broker help you find out.
IR35 legislation was introduced in 2000 to target individuals operating under a limited company but who are in fact working more in the manner of an employee. IR35 was enforced in order to target these so called ‘disguised employees’ that take-home contractor rates but should be earning employee rates. In a nutshell it was designed to ensure that contractors are paying the correct levels of tax.
2018 changes to IR35 rules
Since this point significant changes have been made to IR35. As it was previously up to the contractor to decide and declare whether their contract was inside or outside IR35, as of April 2017, for contractors working in the public sector the decision was now left up to the client.
Further changes to IR35 rules that were announced in the 2018 Budget mean that private firms with over 250 employees will be responsible for checking the IR35 status of a contractor from April 2020.
There are fears that the new rules could increase the amount of tax paid by contractors and encourage clients to take a cautious approach to IR35 in order to limit their liability.
What else affects a contractor’s income?
As well as IR35, there are other factors that affect how much money a contractor will take home.
In some cases, contractors can utilise their partner’s personal allowance to lower their tax bill. Under the Marriage Allowance, contractors that are married or in a civil partnership can transfer part of their tax-free personal allowance to their partner, and vice versa.
From £11,850, that means a contractor can transfer up to £1,190. At the 20% tax rate, that is up to £238 per year taken from the tax bill and instead added to a contractor’s net income.
Whilst contracting, there are business expenses you will incur – from travel, equipment to entertaining clients.
Contractors can choose to either offset some of their expenses against their tax bill or claim certain costs back from the client. Either way, being savvy about expenses can help maximise your income.
Another factor that can impact a contractor’s income is the legal requirement for insurance. Contractors are legally required to take out cover for professional indemnity insurance in the event that their work causes damage or harm to the client or customer. Many clients also require contractors to cover themselves with public liability insurance too, to protect against the possibility to a contractor’s work causing harm or loss.
Those contracting through an umbrella company will have insurance provided for free by the company. However, those contracting under a limited company will need to pay for insurance out of their own pocket.
Holiday, sick and maternity or paternity pay
Although contractors earn more money on average than their employee counterpart, those working under a limited company must consider that they will not receive holiday, sick or maternity pay. This will therefore need to be accounted for in a limited company contractor’s finances.
Those contracting through an umbrella company, on the other hand, will receive statutory benefits such as holiday, maternity or paternity and sick pay.
Concerning pensions, a limited company contractor will need to account for their own pension contributions, which can be offset against tax.
For contractors operating through an umbrella company, pension contributions will work just as they do for employees. There is the choice to opt out of a pension scheme and decide how much in contributions one would like to make.
How much can you earn as a contractor?
Many factors impact a contractor’s income, from new IR35 rules, marriage allowance, childcare credits, pension contributions to tax. There are many options open to contractors and it is important to understand the impact these decisions have on take home pay.
Then, there’s the matter of how you choose to contract which impacts income. Of the three options, limited company, sole trader or umbrella, using an Umbrella company is often considered the most hassle-free way of contracting and offers many of the benefits akin to those received by employees.
Due to the many variables that can effect a contractor’s income, it is always best to compare what you could be taking home using the Umbrella Broker Calculator. Using a calculator, you can work out exactly how much you can earn taking all factors into account.
Then, having compared rates, contractors can change their answers to see how it affects their results. This helps contractors determine the most efficient way for them to contract and maximise their take home pay.