When I quit my job to run my own business, one of the hardest parts of transitioning from being an employee working at a traditional job to being a contractor with multiple clients was realizing the difference between the two, and what an hourly rate means.
It doesn’t matter what kind of contractor you are. You could be a digital nomad, a freelance writer or creative worker (like me), or even a temporary contract worker for many different businesses.
If 1099 income is your main source of revenue, you need to know the difference between being a contractor and being an employee.
Contractors have the responsibility of paying more of their own expenses and providing their own job “benefits.” Even though I knew this before I quit my job, the reality of what that means didn’t hit me right away.
Most full-time, regular employees don’t have to worry about how to pay for things like self-employment taxes, health insurance, disability insurance, life insurance, and more. Employees do pay for some of these benefits. But they are usually taken out of their pay automatically before a check or deposit is issued.
As a contractor, these expenses have to be factored into your rates when you price your services. You need to charge enough for your services to ensure you can pay for these expenses and still earn a living wage.
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A couple of months after I quit my job, I finally sat down to calculate how much these benefits were costing me. I wanted to see how much I was really earning per hour after paying for them.
To my surprise, I was actually earning less per hour as a contractor than I had been as an employee.
Luckily – depending on what kind of business or service you offer – being a contractor can mean more flexibility. When making the transition from employee to contractor, you need to keep in mind that you are now the boss.
If you realize you aren’t charging enough to make up for these expenses, you have the freedom to raise your rates.
Clients may push back. However, I’ve found that most clients are more willing to consider my rate increase after I remind them I have to pay for these expenses.
The differences between being an employee and an independent contractor don’t stop there. Some employees also have the benefits of paid time off and an employer-sponsored retirement plan. These are the things I miss most about being an employee with a traditional job.
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When you’re a contractor, if you don’t do the work, you don’t get paid. This can mean trying to “push through” when you are not feeling well. It also translated into working long hours to meet deadlines before taking a vacation.
If you find that you don’t seem to be making enough to pay for your expenses, take much-needed time off, and still earn a living wage as a contractor, you could be setting your rates too low. In order to find out if you are charging enough for your work, follow these steps.
1. Decide how much money you want to earn annually.
Let’s say you want to earn $80,000 annually, after business expenses.
2. Add up all of your business expenses and all the taxes that you’re responsible for as a freelancer.
Don’t forget things like:
- Office or coworking space
- Domain and web hosting costs
- Accounting software
- Invoicing and PayPal fees
- Cell phone expenses
- Laptop and equipment
- Marketing expenses
- Accountant fees and tax prep
- Self-employment taxes
- Health Care Insurance Costs no longer covered by an employer
According to the Freelancers Union, these expenses can add up to about $22,513 each year.
3. Add your total annual expenses to your desired annual salary to see how much your business has to earn to really pay you $80,000 annually.
In this example, that would be $80,000 + $22,513 = $102,513
4. Figure out a rough estimate for billable hours per year.
Don’t forget to include time off for vacations, holidays, sick time, and more. Plus, as a contractor, not every minute you spend working is billable time.
When you work on things like invoicing or accounting, you typically can’t bill any client for those hours.
If you figure three weeks’ vacation time, seven holidays, five sick days, and 25 percent of your time spent on unbillable projects, you are left with approximately 1,400 billable hours each year.
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5. Divide your adjusted annual earnings ($102,513) by the billable hours per year (1,400).
$102,513 ÷ 1,400 = $73.22 per hour. You might want to try to earn $75 per billable hour in order to provide yourself with a little cushion.
Of course, these calculations will vary depending on the kind of services offered. They also depend upon the state of the markets and the ability of the clients to pay. A plumber, hairstylist, freelance writer, and anesthetist will each have to do separate calculations to arrive at their ideal hourly rate!