Contract vs. Permanent Work: Which Is More Profitable?

There are many reasons why permanent employees decide to turn their backs on permanent work and focus on contract work. Some prefer the flexibility that comes with contract work, while others enjoy the wider variety of work. Contract work operates outside of corporate politics and networking. Contractors can make their own decisions about what type of work they take on, providing a wonderful sense of control.

But let's be honest: most people shift from permanent to contractor work in part because of the opportunity to make more money. But do contractors really earn more than permanent employees doing similar work? Let's take a closer look at whether contract work really is more lucrative.

What are these?

Contractors Earn More

It is a generally accepted fact that on average, contract work earns contractors more than their permanent work counterparts. Several factors contribute to this:

  • Lower Taxes. Contractors who operate outside of the IR35 tax legislation are subject to significantly less tax on their gross earnings compared to employees on permanent work. Even when the cost to the company is identical, contractors benefit from lower taxes and higher take home pay, provided they allocate their salary and profits wisely.
  • More Deductions. Contractors can claim a wide range of tax deductible expenses, which further reduce the net income that is subject to taxation. Here again, contractors outside of IR35 benefit more. While the expenses that contractors can deduct vary depending on IR35 status, they can include: gross salary, travel expenses, administrative and business expenses, and computer costs.
  • Greater Expertise... Higher Rates. Frequently, contractors are able to charge premium rates for their services because they have developed skills that are in demand. Unlike many employees in permanent work, contractors can choose the skills or services they wish to acquire. By combining their industry knowledge with training and practical experience, contractors can often charge higher rates for "cutting edge" work.

The Hidden Costs of Contract work

While the economic benefits of contract work are undeniable, there are some hidden costs and other factors that contractors should consider:

  • Sick Leave and Holidays. Depending on the nature of the job, contractors do not typically receive paid sick leave or paid holidays, and they are paid only for the actual work they perform and deliver. Generally, when a contractor is sick or on holiday, he or she is not paid for this time, unlike an employee on permanent work.
    However, many contractors (particularly those with longer term contracts) find they are able to incorporate holiday time within an existing contract, without impacting their ability to deliver their work on schedule. Some contractors take longer holidays between contracts, while others view such breaks as completely "dead", unpaid time. When taking time off during an existing contract, contractors should discuss the timing and duration with the client to make sure it is acceptable.
  • Health Insurance. Unlike their employee counterparts on permanent work, contractors who are unable to work due to accident or illness are not protected against financial loss. Whereas employees are typically eligible for paid "sick days" and several months of pay if they are unable to work, contractors do not receive any similar benefit. Hence, contractors should consider purchasing permanent health insurance (PHI) to provide such coverage. A range of policies are available based on the percentage of income a contractor wishes to protect and other variables. Contractors are advised to set aside a certain amount each month to cover the costs of a PHI policy.
  • Indemnity Insurance. Professional indemnity insurance protects contractors against legal claims in cases where their client claims some loss resulting from the contractor's work or actions. While an added expense, all contractors should seriously consider obtaining indemnity insurance, since doing without it can put a contractor's business and career at risk.
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  • Pensions. Contractors who invest in a pension are not only securing their financial future, they're also reducing their current tax burden. In particular, contractors who pay taxes under IR35 can realise significant tax relief by contributing income to a pension as opposed to drawing it as salary. The exact tax benefit depends on IR35 status, the contractor's age and other factors, but pensions are a sensible option that all contractors should consider.

Some experts recommend that, in order to cover some of these hidden costs of contract work, contractors should plan to earn at least 20% more than what they would earn as an employee on permanent work. They say that will help preserve their quality of life into the future.

A Solid Financial Future

The financial incentives of working as a contractor can be quite compelling. At the same time, contractors should be aware of the key differences between permanent and contract work. By carefully planning for the hidden costs, contractors can go a long way toward ensuring a successful and stable career.