Or Why I don’t accept $60 an hour and you shouldn’t either.
When I started freelancing I found myself asking how much I should be charging my clients (or more so, how much I should be paying myself) and I’ve seen many other freelancers asking the same questions.
I knew how much I was making as a W2 but how does this translate to being a 1099 worker?
After some poking around I’ve found that many freelancers vastly underpay themselves for their services.
There are many different ways to handle this equation but I’d like to share the solution that worked out for me.
I’ve found it best to calculate a “Minimum Pay Rate” (The absolute minimum you should accept for a role) and “Desired Pay Rate”.
Differences between W2 and 1099 workers
Let’s consider the differences between a W2 and a 1099 worker in regards to benefits and pay.
As a W2 worker
An employer often provides numerous benefits that are often unaccounted for.
- Employer matching of Medicaid and Social Security taxes (Also called Payroll Taxes)
- Sick leave
- Vacation leave
- Holiday leave.
- Health/Dental/Vision benefits
- Regularity of pay (You know that each month you’re making X amount of money at Y time)
- 401k benefits
As a 1099 worker
- You are responsible for your own expenses, accounting, time tracking, and more.
- You are responsible for Self Employment tax, this is essentially the Payroll tax that was previously matched by an employer.
- A decent portion of your time is unbillable, meaning you are unable to charge them to a client. This includes learning new skills, writing proposals, and sourcing new work.
So now that we understand some of the differences between a W2 and 1099 worker, let’s take a look at someone making $110,000 a year ($52.88 an hour) as a W2 employee (A reasonable salary for mid-level Devops/Automation work in the Austin area.).
Minimum Pay Rate
The first thing we’ll want to calculate is our “Minimum Pay Rate”.
Lucky for us, the nice folks over at Bankrate calculated that approximately 30% of your compensation as a W2 employee are benefits and employer paid taxes.
As a W2 employee, our hourly rate equates to $52.88 an hour. We calculate this based on 2080 hours a year since the benefits calculated by Bankrate includes leave time.
The first thing we’ll want to do is immediately add 30% to cover our benefits.
A big thanks to user “notimportant” over at Hackaday who helped me correct some mistakes in my math.
(benefits+pay)*0.7 = employee pay
Solving for this we know that:
benefits +pay = (pay)/.70
$53 an hour / .70 = $75.71 an hour
Right off the bat we are already looking at approximately $76 an hour or $156,000 a year to account for the lost benefits.
Now lets calculate the hours we have for work each year assuming we want a 2 week vacation, 1 week sick/I hate work days, and federal holidays (10 days).
2080 hours a year – (((2*5)+(1*5))+10)*8) = 1880 hours a year
Lets make a conservative estimate that only 80% of our hours are billable.
1880 * 0.80 = 1504 hours
This leaves us with 1504 hours to handle all our work.
$152,000 a year/1504 hours a year = ~$101 an hour
So to simply reach our previous salary of $110,000 a year we would need to charge approximately $101 an hour to account for our pay (and just as importantly) our benefits.
For this reason, you (generally) should not accept any less than $101 an hour for your services.
Exceptions might be made for clients that agree to give you a minimum amount of billable hours over a set period of time (30 hours over a year long period) or in cases where you’re willing to accept a pay cut for work (For example $100,000 a year has a minimum rate of approximately $92 an hour)
Desired Pay Rate
We’ve now calculated our Minimum Pay Rate but if we just wanted to make the same amount as before, why bother becoming a freelancer at all? We’re business people dammit!
Since we’re business people, lets assume that we’d like to make a healthy 12% profit over what we were making as a W2 employee.
Let’s multiply our Minimum Pay Rate of $101 an hour by our desired profit margin.
$101 an hour * 1.12 = ~$113 an hour
That gives us approximately $113 an hour for our Desired Pay Rate.
If you can charge more? Go for it! You’re a business, you should think like any other business. Optimize for what your customers can pay.
What about Project Based Pricing?
Some freelancers/consultants prefer (and HIGHLY suggest) utilizing project based pricing or value based pricing instead of hourly pricing.
If you’re able to effectively scope the project and perform the work quickly this is a great way to balloon your effective hourly rate.
My thoughts (From the perspective of a Devops/Automation guy) is to work on some hourly projects to get an idea of the time required and then move to value based or project based pricing once I build up a tool set and better understand scope.
A Note On Taxes
It’s important to remember that even though you may bring in approximately $172,000 a year assuming you can bill all 1504 hours at your Desired Pay Rate that anywhere between 25%-30% of this is taxes (Uncle Sam has to get his cut).
It’s important to save 30% of each paycheck as you must pay quarterly taxes!
Failure to pay these quarterly taxes can result in a pretty stiff penalty from the IRS.
You can see how to calculate your estimated penalties here under the section titled “Simple Method”.
Our $172,000 a year would give us a tax burden of approximately $57000 a year.
The BEST tax calculator I’ve found for Freelancers is by H & R Block.
You can find it here.
It will calculate your Self Employment Tax + Income Tax along with any expenses.
In short, a lot of people vastly underestimate the amount of money they should be making as a freelancer to match their W2 pay.
Be sure that you’ve done some basic number crunching and market research to understand your real value.