Umbrella payroll: what is it and how does it work?

The difference between umbrella payroll and traditional payroll is who is considered the employer. With umbrella payroll, the umbrella company or agency is considered to be the employer. With traditional payroll, the hiring organisation itself is the employer.

Payroll refers to the process of managing employee payments. In the usual scenario, an employee is directly employed by a business and that organisation will handle all aspects of employment — including payroll.

However, when an employee is legally employed by a payroll company, the hirer (the company where the employee works) outsources the payroll management. In this arrangement, the employee is not formally hired by the business they work for. Instead, it's the umbrella payrolling company that becomes the legal employer, and the employee is then assigned to the client or 'hirer'.

An umbrella payroll company takes on the responsibility of legally employing your staff. This includes tasks like managing payroll administration, creating contracts, updating employee details, handling time-off and annual leave, preparing pay slips, and more. This approach offers significant time savings for employers — especially when dealing with short-term staff.

By transferring legal employment to the payroller, employers can reduce their risks. For example, sickness insurance and premiums are fully managed by the payroll company. The hiring organisation continues to select and manage the workforce, but the umbrella company handles all administrative aspects.

Umbrella companies usually operate on a pre-agreed, all-inclusive rate. They bill the hiring organisation for each hour worked by the employee. This rate covers not just the employee's salary, but also other costs typically borne by the employer — such as holiday pay, annual leave, and pension contributions.

The advantage of using an umbrella company is that your business pays a fixed hourly rate which includes premiums and payroll taxes. Typically, umbrella companies charge a rate based on the employee's salary plus a small margin for their services — generally around 6-10%.

Simplify your payroll tasks

Prepare your payroll more efficiently for accounts. Enable employees to change personal data themselves that HR approves. Working hours and bonus details are automatically transferred to your payroll system.

Streamline how you pay employees

An umbrella company offers numerous advantages for employers compared to hiring through employment agencies or temporary staffing firms. The most significant benefit is that you are no longer the legal employer for employees, so you save time on admin and reduce risk around employment law and payroll compliance.

Benefits for employers include:

• Reduction in time spent on HR admin, including payroll

• Lower compliance risks

• Less financial impact from the costs of absenteeism, incapacity, or severance payments

• Flexibility to bring in new employees as and when they're needed with fewer complications

Relying on an umbrella company for payroll can also have disadvantages. The drawbacks for employers include:

• Potentially higher costs than hiring and paying directly

• Clarity around costs depends on how transparent the umbrella company is

• Quality employees may end up working for another business through the umbrella company

• Most third-party payroll companies aren't available 24/7, which can create issues if last-minute administrative tasks arise

Cooperation between your HR team and the umbrella company involves overlapping tasks, but each party also has distinct responsibilities. The HR department handles recruitment, selection, supervision, and employee development, while the umbrella company focuses on employment duties, payroll, and employee records. Effective collaboration between both parties is crucial.

Many organisations use umbrella companies to manage temporary workers or to relieve some of the pressures of acting as the employer, like worrying about HR compliance or preparing accurate records for payroll. If you're considering a third-party payroll service for these reasons, there's an alternative to consider: using an intelligent HR platform like Personio.

Personio users benefit from:

• Core HR including onboarding, absence management, workflow automation, and people analytics in one platform

• Preliminary payroll for accurate, up-to-date data ready for payroll runs

• Integrations with popular UK payroll tools, including Xero and Sage 50

• An HR system designed to support UK and EU compliance

In some cases, umbrella payroll makes sense. But if you're looking for a better way to manage HR and preliminary payroll in one place, try Personio.

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Yes, using an umbrella company is still allowed. Umbrella payroll, off-payroll working, and engaging contractors through their own personal company are all acceptable, as long as you can demonstrate compliance with IR35 rules. The employer is responsible for assessing whether contractors fall within the scope of IR35 and should be treated as employees for tax purposes: it's important for both contractors and clients to be aware of the rules.

While employment agencies and umbrella companies share similarities, there are distinct differences. An employment agency primarily focuses on recruiting and selecting employees, although they can also act as the employer. An umbrella payroll company relieves the employer of administrative tasks and requirements, including payroll, but recruitment and selection still sits with the hiring organisation.

In the context of employment, including umbrella payroll, both employers and employees are required to contribute to National Insurance (NI) and pay Income Tax. If you use an umbrella company, they will handle the collection of tax and other contributions on behalf of the hiring organisation.

The costs of umbrella payroll in the UK can vary based on several factors, including the type of arrangement and the specific services provided. Key considerations that contribute to the costs of payrolling include the contractor's income, National Insurance Contributions (NICs), income tax, business expenses, IR35 status, professional advice, company operating costs, and other costs.

An umbrella payroll contract is initially established with the employee, the umbrella company, and the hiring organisation. The employee is formally employed by the payroll company, which manages paying the employee's salary and holiday allowance, as well as creating pay slips and annual statements.