Permanent vs Contractor Calculator 2025/26

Permanent vs Contractor in the UK

One of the most common career decisions for UK professionals, particularly in technology, finance, and consulting, is whether to work as a permanent employee or as a contractor. The decision involves trade-offs between job security and earning potential, between simplicity and flexibility, and between guaranteed benefits and tax efficiency.

A permanent employee receives a fixed annual salary paid through PAYE (Pay As You Earn). Their employer handles all tax deductions, National Insurance contributions, and pension auto-enrolment. The employee also receives statutory rights including 28 days paid holiday (including bank holidays), statutory sick pay, maternity and paternity leave, redundancy protection, and unfair dismissal rights after two years of service.

A contractor, by contrast, works on a project basis and is typically paid a daily or hourly rate. They may operate through their own limited company (outside IR35) or through an umbrella company (inside IR35). Contractors do not receive statutory employment benefits, must arrange their own insurance, pension, and holiday cover, and bear the risk of gaps between contracts.

Understanding IR35

IR35 is the informal name for the off-payroll working rules contained in Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003. These rules exist to prevent tax avoidance by workers who would be employees if engaged directly, but who instead work through an intermediary such as a limited company.

Since April 2021, for medium and large private sector clients, the responsibility for determining IR35 status lies with the end client rather than the contractor. The client must issue a Status Determination Statement (SDS) for each engagement. If the determination is that the engagement falls inside IR35, the fee-payer (usually the agency) must deduct income tax and NICs at source, as if the contractor were an employee.

A contract is likely to fall inside IR35 if the contractor has no right of substitution (they must do the work personally), is subject to the client's control (how, when, and where they work), and there is mutuality of obligation (the client must provide work and the contractor must accept it). Contracts outside IR35 typically demonstrate genuine self-employment through factors such as the right to send a substitute, financial risk (fixed-price contracts), provision of own equipment, and no ongoing obligation outside the specific project.

Ltd Company vs Umbrella Company

When a contract is outside IR35, most contractors operate through their own limited company (often called a Personal Service Company or PSC). The limited company invoices the client or agency for the contractor's services. The contractor is both the director and the sole employee of their company.

The tax-efficient extraction strategy involves paying a salary at the personal allowance level (£12,570 for 2025/26) and taking the remaining profits as dividends. This works because:

• Salary at £12,570: No income tax (covered by personal allowance) and no employee NI (below primary threshold). Employer NI applies above £5,000 but can be offset by the Employment Allowance.
• Corporation tax on profits: 19% for profits under £50,000 (small profits rate), rising to 25% for profits over £250,000.
• Dividends: First £500 tax-free (dividend allowance), then taxed at 8.75% (basic rate), 33.75% (higher rate), or 39.35% (additional rate).

When a contract is inside IR35, the contractor typically works through an umbrella company. The umbrella company is the legal employer and processes the contractor's pay through PAYE. From the assignment rate, the umbrella deducts its own margin (typically £20-30 per week), employer NI contributions, and then processes the remaining amount as a salary subject to standard income tax and employee NI deductions.

How Contractors Pay Less Tax

The reason contractors outside IR35 typically pay less tax than permanent employees comes down to the different tax treatment of dividends compared to salary. Consider a contractor earning £78,000 per year through their limited company:

Compare this to a permanent employee on the same gross income who would pay 20% basic rate tax and 40% higher rate tax on salary above £50,270, plus 8% employee NI (2% above the upper earnings limit). The combined effective tax rate for the contractor is significantly lower.

However, it is important to note that the contractor must also pay corporation tax on company profits before dividends can be distributed. The combined effective rate (corporation tax plus dividend tax) is designed to be closer to the equivalent income tax rate, but there is still an overall saving, primarily from the avoidance of employee National Insurance on dividend income.

The Hidden Costs of Contracting

While the headline day rate may look attractive, contractors face several costs that permanent employees do not:

• No paid holiday: 25 days of unpaid holiday at £400/day costs £10,000 in lost revenue
• No sick pay: A week off sick costs £2,000 in lost revenue
• No employer pension: A 5% employer pension match on £50,000 is worth £2,500/year
• Accountancy fees: Typically £1,000-2,000 per year
• Professional indemnity insurance: £200-500 per year
• Gaps between contracts: Even a month between contracts costs a full month of revenue
• No training budget: Contractors fund their own professional development
• IR35 risk: A retrospective IR35 determination can result in significant backdated tax liabilities

When to Go Permanent

Permanent employment may be the better choice when:

• You value job security and predictable income
• You are applying for a mortgage (lenders prefer permanent income with payslips)
• The employer offers generous benefits (pension matching over 5%, private healthcare, share schemes)
• You want career progression within a specific organisation
• The available contractor rates are not significantly higher than the permanent equivalent
• Your contracts would likely fall inside IR35, reducing the tax advantage
• You prefer a simpler tax situation without Self Assessment, company accounts, and VAT

Pension and Benefits Gap

One of the most overlooked aspects of the permanent vs contractor comparison is the pension gap. A permanent employee with a 3% employer pension contribution on a £50,000 salary receives £1,500 per year in free pension contributions. Over a 30-year career, assuming 5% annual growth, this employer contribution alone could grow to over £100,000 in pension value.

Contractors must fund their own pension entirely. While pension contributions through a limited company can be tax-efficient (they are a deductible business expense), the discipline and planning required means many contractors under-save for retirement. When comparing permanent and contractor options, always factor in the employer pension contribution as part of the total compensation package.

Other benefits that are easy to overlook include: death in service cover (typically 4x salary, worth £200-500/year in equivalent life insurance premiums), income protection insurance, private medical insurance (£1,000-2,000/year equivalent), and share option schemes. These can add 5-15% to the value of a permanent compensation package.

Worked Examples

Example 1: £50,000 Permanent vs £400/day Contractor

A software developer comparing a £50,000 permanent role with 3% employer pension against a £400/day contractor rate:

• Permanent take-home: £50,000 gross, approximately £38,500 after tax and NI
• Contractor revenue (outside IR35): £400 × 195 days = £78,000
• Contractor take-home (outside IR35): After expenses, corp tax, and dividend tax, approximately £60,000-62,000
• Contractor take-home (inside IR35): After umbrella margin, employer NI, tax and NI, approximately £50,000-52,000
• Permanent total package: £50,000 + £1,500 pension = £51,500

In this example, the contractor outside IR35 takes home approximately £22,000 more than the permanent employee, but inside IR35 the advantage shrinks to approximately £12,000-14,000. After accounting for lost holiday pay, no sick pay, and no employer pension, the true benefit of contracting is around £12,000-15,000 per year outside IR35.

Example 2: £80,000 Permanent vs £600/day Contractor

A senior consultant comparing a £80,000 permanent role with 5% employer pension and private healthcare against a £600/day contractor rate:

• Permanent take-home: £80,000 gross, approximately £55,000-57,000 after tax and NI
• Contractor revenue (outside IR35): £600 × 195 days = £117,000
• Contractor take-home (outside IR35): After all deductions, approximately £85,000-90,000
• Contractor take-home (inside IR35): Approximately £70,000-75,000
• Permanent total package: £80,000 + £4,000 pension + £1,500 healthcare = £85,500

At higher day rates, the tax advantages of contracting outside IR35 become more pronounced. However, the higher rate tax band means that a greater proportion of dividend income is taxed at 33.75%, reducing the relative advantage. The permanent total package with generous pension and healthcare benefits is harder to replicate as a contractor.

Common Mistakes When Comparing

1. Ignoring the Total Compensation Package

Focusing solely on take-home pay ignores the value of employer pension contributions, death in service cover, private healthcare, and other benefits. A £50,000 salary with 10% employer pension match is effectively worth £55,000 before any other benefits are considered.

2. Not Accounting for Unbilled Days

Contractors often overestimate their annual revenue by not accounting for holidays, sick days, and gaps between contracts. A realistic assumption is 195-200 working days per year, not the full 252 business days. Some contractors may also face periods without a contract, especially during economic downturns.

3. Assuming Outside IR35 When the Contract is Inside

Since the 2021 changes, many roles that were previously considered outside IR35 now fall inside. If your contract is inside IR35, the tax advantages largely disappear and you may be worse off than a permanent employee when accounting for lost benefits. Always check the IR35 status before making financial comparisons.

4. Forgetting About Mortgage Applications

Mortgage lenders typically offer less favourable terms to contractors. Some lenders require two to three years of company accounts, and they may use the lower of salary or salary plus dividends for affordability calculations. If you are planning to buy a property, the simplicity of permanent payslips can be a significant advantage.