Are you a salaried employee looking to switch to a W-2 or 1099 contractor? (For an explanation of W-2 and 1099, click Consultants: 1099 or W-2?) If so, what hourly pay rate would you need to at least match your salary?
When trying to decide the equivalent pay between being a Permanent/Salaried/Full-Time employee (“Perm”) compared to being a W-2 or 1099 Contractor/Consultant (“Consultant”), here are some things to keep in mind:
- Amount of income – What is your salary and what is the consulting pay rate you are comparing?
- Dental/Medical/LTD/STD/Life – Usually you have to pay a lot more in medical premiums as a consultant, to the tune of $500/month for a family plan (and were talking a $7500 individual deductible with no maternity coverage, no pre-existing condition coverage…better coverage can cost a LOT more)
- Vacation – Perms get paid vacations, consultants only get paid when they work
- Sick – Perms get some paid sick days, consultants do not
- Holidays – Perms get paid holidays, consultants do not
- Bonuses – Perms sometimes get bonuses, consultants do not
- Taxes – You must pay 7.65% in self-employment taxes if you are 1099
- Moving expenses – Sometimes as a perm you will get your moving expenses paid, but not as a consultant
- Misc expenses paid (i.e. cell & internet) – Sometimes as a perm you will get miscellaneous expenses paid, but not as a consultant
- 401k – Some companies match a percentage of your contribution to a 401k if you are a perm
- Stock options – Sometimes as a perm you will get stock options
- Bench time – As a consultant, if you are on the “bench” (i.e. in-between projects), you don’t get paid: you are only paid when you are working and billing the client
- Training/Certifications/Conferences – Most companies will pay for training if you are a perm, and not only the cost to attend but your salary while you are in training. A consultant has to pay his own costs to attend and does not get paid while attending
- Paid expenses when working at client – Some consulting gigs won’t pay your travel expenses. Perms travel expenses are paid (sidenote: If you have your expenses paid as a consultant, and you drive to a nearby city each week, it’s like having your car payment paid for. Mileage is paid at 55-cents a mile, so a 200 mile trip twice a week gets you around $950/month, subtracting the cost of gas)
- Yearly salary increases – Most perms get annual bumps in salary
- Overtime – Perms don’t get paid for OT, but consultants do
- Frequency of pay – Perms get paid weekly or bi-weekly like clockwork, 1099 consultants have to invoice and wait up to 30 days
- Promotions – Perms usually get promotions every few years. Consultants get “promotions” by finding a project that pays a higher rate
- Annual reviews – Perms have annual reviews by their boss which sometimes results in a pay increase. You are your own boss as a consultant
- Tax deductions – Consultants can “write off” many expenses that a perm can’t
Some other differences to keep in mind that are not related to pay:
- Travel – Perms tend to have very little travel. As a consultant you could travel frequently
- Laptop – Perms get a company-provided laptop. Consultants must buy their own
- Length of contract – As a consultant, you always have an “end date” when you will have to start looking for another project
- Work hours – Perms usually have fixed work hours, but consultants usually have more flexibility
- Type of work (maintenance or development) – Perms tend to have to maintain applications they build, as well as maintain existing applications. Consultants usually move on to another project when one is completed so are frequently doing new development work
- Workers comp/unemployment – Perms are eligible for workers compensation and unemployment. Consultants are not
Note that if you are working as a consultant for a consulting company, but are being paid a salary (NOT as a W-2 or 1099), then I am considering you a “Perm”. Also note that a W-2 contractor is many times brought in to supplement a staff and therefore shares some non-pay related characteristics of a perm employee (i.e. travel, laptop, work hours, type of work, work hours flexibility).
Early in my career, when I was working as a salaried employee for a consulting company (a “Perm”), I was pretty upset when I found out what they were billing the client. That hourly rate was much higher than what I was making (a 70% markup). When I complained to the consulting company, they said I can earn more money by switching to a W-2 employee, but I would miss out on the benefits of being a perm (paid vacation/holidays, higher medical premiums, paid bench time). I did the math and determined those benefits required an extra $4/hr. When I asked how much more an hour I would get W-2 and they said $12/hr, I switched immediately to W2 (a “Consultant”). And what they fail to tell you is if you are on the bench for longer than a week or two, they can you (not to mention the next project they line up for you might be one you don’t care for).
So let’s look at a detailed example for a perm and a consultant:
Perm: Your salary is $90k, with a 10% yearly bonus. You pay $300/m for health insurance. Your company matches up to 3% of your salary for 401k (for which you need to contribute 6% of your salary to the 401k), and you get a little company stock each year worth about $1k. So your “true” salary is around $100k.
Contractor (1099): Your rate is $60/hr. Since you only get paid when you work, subtract out 80-hours for 2 weeks of vacation, 80 hours for 10 holidays, and 40 hours for sick/miscellaneous. Assume $600/m for health insurance and another $100/m for dental. Don’t forget 7.65% in self-employment tax. We will say no bench time or overtime work, and you are not paying for any training. Finally, we will say the tax deductions you get being 1099 save you $5k per year. Doing the calculations, your true salary is around $100k.
So there you have it. Of course there were a lot of assumptions, but it shows that if you make $90k as a perm, which salary surveys shows is a little on the high side of most DBA’s, you would only have to earn $60/hr as a 1099 contractor for the equivalent, which is very much on the low side.
The bottom line is you can usually make a lot more money as a W-2 or 1099 Contractor/Consultant than a salaried position, but there are additional risks and the expectations will be higher (more on this in another blog post).
So why are companies willing to pay more for contractors? Here are the top reasons:
- It’s a different bucket of money – many times a company has a budget to spend on consulting fees, but no budget for hiring a salaried person. And usually there are no rules for how the budget is spent: It could all be spent on one high-priced consultant
- Companies don’t have to pay the overhead that goes with a salaried employee, such as heath insurance, taxes, vacation, etc, which can add 30%-50% of the salary
- Looks better on the company statement (revenue per employee). The lower the employee headcount, the better the company looks to investors
- Cost of contractors is an expense for a company and therefore a tax deduction, whereas a company can’t deduct salaries
- You don’t have to fit into a salary “slot”. When hiring a perm, they have to fit into a salary range so they are not making more than their boss. No such slot exists with contractors and they usually make more than all but the top executives at a company
- Don’t have to train consultants like you do a perm. Consultants can hit the ground running
- Easier to get rid of a contractor if they are not working out compared to a new perm hire