Developer Career Tip #0022---Setting your hourly billing rate--Part 2

Developer Career Tips #0022

Setting your hourly billing rate--Part 2

In my last Developer Career tip, I discussed ways in which an Independent Contractor can go about establishing an hourly billing rate, which concentrated on establishing a rate in concert with those around you. I promised to discuss how to establish your own personal billing rate in this tip--which may be lower or higher than the going market rate.

The first step is to determine the level of 'take home' pay that you can live with each week or month. Of course, this figure will vary from individual to individual, and you may want to use the last job you had as an employee as a starting point. It's important to start out with some figure in mind that you can use for comparison purposes, because as you're about to see, grossing $100,000 a year as a consultant is not the same as grossing $100,000 a year as an employee. Here are the typical deductions for an employee making $100,000…

Salary Figures as an employee..

Gross $100,000
Federal Tax 28% $ 28,000
Social Security 6.2% up to 76,200 $ 4,724
Medicare 1.45% $ 1,450
401K (Employee) 5% (up to 10%) $ 5,000
Health Insurance $300 per month $ 3,600
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Total Deductions $ 42,774
Yearly Net $ 57,226
Monthly Net $ 4,769

These figures assume that you are contributing 5% to a 401K Pension plan, that your employer is matching 5%, that you are paying some share of your Health Insurance Premiums, and that you are paying no State or Local Taxes. As you can see, this results in a monthly net income of approximately $4,769.

This picture gets a bit more complicated as an Independent Contractor, as there are more payroll taxes for you to pay. You may not be aware that as an Independent Consultant, you are required to pay BOTH the employee and employer share of Social Security Taxes. I also HIGHLY recommend that you continue to pay into a 401K Plan of your own. When you're an Independent Contractor you can set up a Simplified Employee Pension (SEP), and you can contribute roughly up to 15% of your Gross Income into this tax deferred, tax deductible plan. Here's how that same $100,000 gross salary looks as an Independent Contractor.

Salary Figures as an Independent Contractor..

Gross $100,000
Federal Tax 28% $ 28,000
Social Security (Employee share) 6.2% up to 76,200 $ 4,724
Social Security (Employer share) 6.2% up to 76,200 $ 4,724
Medicare (Employee share) 1.45% $ 1,450
Medicare (Employer share) 1.45% $ 1,450
401K (Employee) 5% $ 5,000
401K (Employer) 5% $ 5,000
Health Insurance* $600 per month $ 7,200
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Total Deductions $ 57,549
Yearly Net $ 42,451
Monthly Net $ 3,538

These figures assume that you are contributing both the employee and employer share of Social Security and Medicare Taxes, 10% to a 401K (remember, as an employee you contributed 5% and your employer contributed 5%), and about $600 per month for a group health insurance policy.

As you can see, by joining the Independent Contracting ranks, you are taking a 'hit' of $14,775 in your yearly net pay, or about $1,231 per month. To maintain the same level of 'take home' pay, you would need to 'gross' about $125,000 per year.

How do we then determine an hourly pay rate?

To do that, you next need to determine how many hours per year you'll be working. Let's say in your previous job you took 3 weeks of vacation per year, and used a total of 5 personal and sick days, and also were entitled to 5 paid holidays. That's a total of 25 days off (15 + 5 + 5). In a typical work year there are 260 work days (52 * 5)---with 25 days off, that means you worked 235 days. Assuming you'll need the same amount of time 'off' in your life as an Independent, and that you'll be working, on average, 8 hours per day, multiply 8 hours per day by 235, and you get 1,880 hours. Divide 1880 into $125,00, and the result is $66.48--and there you have your billing rate.

But there's one problem with this scenario.

As an Independent Contractor, you can expect to spend about 25% of your time in non-revenue generating pursuits. For instance, you'll need to keep up with the latest in technology, which may mean taking classes on your own time (and at your own expense.) You may also need to make proposals and presentations to potential clients which may not pan out---and which are not billable (I try to bill for everything, but it's not always possible.). Also, as good as you are, you most likely won't be working all the time. One contract may end at the end of March, another one begin two weeks later in mid-April.

For this reason, you need to assume that of those 1,880 hours you are able to work each year, only 75% of them will be billable--which results in about 1,410 billable hours per year---divide that number into $125,000, and you get a more realistic billing rate of $88.

Now at this point, a lot of newcomers question their ability to command that kind of rate---if the rate you require seems too high to you, what can you do?

First, you can reconsider joining the ranks of the Independent Contractor. Independents, as you have seen here, have good reasons for charging the high rates that they do---and usually have the skill sets to get them. If you don't think your skill set can command the rate you need to make, perhaps this is not a good move for you.

Secondly, you can lower your required 'take home' pay. In my experience, this is not a good idea. Under ordinary circumstances, you wouldn't leave one job and take another at lower pay--why accept that scenario just because you're working on your own.

Thirdly, you can increase the number of hours you're willing to work in a year. Some Independents I know work 14 hour days to increase their billable hours, and in turn, charge a lower hourly rate. Some others give up vacation time in order to increase their billable hours. Again, I don't think this is a great idea. As an Independent, you probably were hoping to improve the quality of your life---taking this approach is a sure way to ruin it.

Finally, you can 'skimp' on the benefits that you are now paying yourself. For instance, you can choose NOT to pay into your own 401K, or perhaps cut back a bit on the amount you contribute. This is a VERY bad idea. Your retirement plan is insurance for your future. Think how you would feel if your employer announced today that they were eliminating your pension plan, or no longer matching your 401K contributions. You'd be up in arms.

The bottom line is to find a billing rate that allows you to live as comfortably as you deem fit--and for most people, that means earning a 'take home' pay that is at least as much as you earn now. If you can't do that as an Independent, then the lifestyle is not for you.