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Summary
Comparing a contractor day rate to a permanent salary requires accounting for the benefits, costs, and tax implications that differ between the two arrangements. A £500/day contract is not equivalent to a £130,000 salary — once you subtract holidays, pension, employer NI, sick pay, and other permanent benefits, the true comparison is quite different.
How it works
Converting a day rate to an equivalent salary
A contractor works approximately 220-230 days per year (52 weeks x 5 days minus holidays and gaps between contracts). The equivalent annual revenue is:
Annual contractor income = Day rate x Working days
But this revenue must then fund everything a permanent employee gets for free:
- No paid holiday (lose ~25 days of income)
- No employer pension contribution (typically 3-10% of salary)
- No sick pay beyond SSP
- No employer NI saving (if operating through a limited company outside IR35)
- Professional indemnity insurance, accountancy fees, equipment
The comparison calculation
Permanent equivalent of day rate:
- Start with: Day rate x Working days (e.g., £500 x 220 = £110,000)
- Subtract: Unpaid holiday cost (25 days x £500 = £12,500)
- Subtract: Pension equivalent (5% = £5,500)
- Subtract: Company running costs (~£3,000-£5,000/year)
- Equivalent salary: ~£87,000-£89,000
Day rate equivalent of salary:
- Start with permanent salary: £80,000
- Add employer NI: ~£11,250
- Add employer pension (5%): £4,000
- Add holiday pay value: ~£8,000
- Total employer cost: £103,250
- Divide by working days (220): ~£469/day
IR35 implications
Outside IR35: The contractor operates as a genuine business, taking income as a mix of salary and dividends through a limited company. Effective tax rate is typically lower than equivalent PAYE.
Inside IR35: The contractor is taxed as if they were an employee. Income tax and NI are deducted at source by the end client or agency. The tax advantage of contracting largely disappears, though higher day rates may still compensate.
Worked example
Contractor: £550/day, 220 days/year, outside IR35
- Gross revenue: £550 x 220 = £121,000
- Costs (accountant, insurance, equipment): -£4,000
- Corporation tax (25% on profits): -£29,250
- Available for salary + dividends: ~£87,750
- Optimal extraction: £12,570 salary + £75,180 dividends
- Tax on dividends: ~£13,500 (at 8.75%/33.75%)
- Net income: ~£74,250
Permanent: £85,000 salary, 5% employer pension
- Income tax: ~£18,432
- Employee NI: ~£4,211
- Net salary: ~£62,357
- Employer pension in pot: £4,250
- Net + pension: ~£66,607
The contractor nets about £7,600 more per year, but has no pension, no holiday pay, and carries more risk.
Inputs explained
- Day rate — the contractor’s daily charge rate
- Annual salary — the permanent role’s gross salary
- Working days — estimated billable days per year (typically 220)
- IR35 status — inside or outside, which changes the tax calculation
- Employer pension % — the permanent role’s pension contribution
Outputs explained
- Like-for-like comparison — both converted to the same basis
- Net income comparison — take-home pay under each arrangement
- Break-even day rate — the minimum day rate that matches the permanent salary
- Benefits gap — the value of permanent benefits the contractor must self-fund
Assumptions & limitations
- IR35 status significantly changes the calculation. Inside IR35 removes most contractor tax advantages.
- Does not model dividend allowance changes or personal circumstances that affect optimal salary/dividend split.
- Contract gaps are a major risk. If you only secure 200 days instead of 220, income drops by 9%.
- Assumes the contractor operates through a limited company, not as a sole trader or umbrella company.