As more and more companies look to hire contractors instead of full time employees to get work done you may find yourself considering a contracting gig for the first time in your career. A recent study suggests that by 2020, 40 percent of America’s workforce will be contract, temporary or self-employed workers.
Many people may shy away from contracting jobs because they often do not offer paid time off or benefits. However, you can receive a much higher hourly rate on a contracting job then you would on a fulltime job. The benefits and paid time off are not FREE and your fulltime employer will pay a lower salary to cover those things.
You can successfully build benefits and paid time off into your contracting rate and feel comfortable that your contracting gig will be at least equivalent to a fulltime salary plus benefits.
Finding your hourly rate
Alice is a full stack developer who has just left a fulltime position where she was making 150K with 2 weeks vacation, medical benefits, 401K. She wants to figure out what her equivalent hourly rate would be as a contractor.
First she should take her 150K salary and divide that by the number of hours she plans to work in the year. There are 40 hours per week and 52 weeks per year so a full year with no time off would have 40×52 =2080 hours. Since Alice wants to take off 2 weeks for vacation and an additional 10 days for holidays she should reduce the yearly hours by 20 days * 8 hours/day = 160 hours. So her hours per year will be 1920.
Taking her $150,000 and dividing it by the 1920 hours gives her an hourly rate of $78/hour.
1099 or your own Corporation vs. W2
Before determining her rate Alice must know if she will be a 1099 contractor or work on the w2 of a staffing agency. The difference being that as a W2 employee the employer will withhold taxes and pay employer taxes. As a 1099 contractor or if you are working under your own corporation you will need to account for these employer taxes which will be approximately 15%.
Adjustments for Benefits
- Add $7K – Alice is single and health insurance will cost her 7K per year
- Add $11,475K (7.65%) for the extra tax Alice will pay for self employment. This is what her employer used to pay the Government (Employer Taxes). If Alice’s contracting position is with a staffing company on a W2 then this does not need to be added.
- Add for 401k matching – $6K
- Total addback for benefits and taxes for Alice equal $24,475, ($24,475/1920 hours = ~$13 dollars per hour.)
- Alice’s Rate goes up to $78/hr+$13/hr= $91/hr on 1099
- If Alice were a w2 staffing employee she can remove the additional self employment tax number so her total add on would be 13K/1920 hours = ~7/hour, so w2 staffing rate will be 78/hour + 7/hour = $85/hour w2 staffing rate
Adjust for Downtime
There may be downtime in contracting so Alice should adjust her rate to account for fluctuations in your projects. If we assume Alice will be spending about 3 months per year finding clients/off a project her utilization rate will be 80%.
Adjusting- $91/hr/0.8 = $114/hr on 1099
We have put together a calculator you can use here to calculate your personal hourly rate.
This is a great exercise to come up with a target hourly rate that you can use to start negotiations with a client. You can generally lower your rate for longer term contracts as your utilization rate will increase. Ultimately you will need to test your rate out on the market and negotiate, negotiate, negotiate.