Deciding your hourly rate. The real costs of freelancing

How many freelancers have you met that you think “Man. I want to be that guy! He makes a stupid amount per hour and does half the work I do. I need to plan to go freelance somehow, be my own boss. I’ll be happy and rich!”

If you think this — stop deluding yourself. It’s not nearly that sexy. Hopefully by the end of this article, you’ll better understand the reality of being paid on a freelance basis and the true costs of being your own boss from a fiscal point of view and why your hourly rate is so important. (Note these lessons generally apply to a project based pricing structure to a degree).

So let’s start with some hard numbers and an example. “Jane” our prototypical freelancer charges a $125 an hour. Jane is a relatively senior person who has been around the block. People value her work and ability to work independently, deliver solid results and be able to move quickly. Before Freelancing she was making roughly $180,000 in a Lead Design/Dev/UX/Pick Your Position at ACME Co, until she decided to throw off the chains of the man and make it on her own.

Take a quick guess at how much you think her income is pretax…

Most people I meet jump to the conclusion Jane makes $260,000 freelancing and think she’s hit the jackpot. — This is false.

(If you came to a much lower number — kudos).

But wait — how did you get that number or whatever number you did? Most people I’ve talked to generally think $125 * 8 Hours a day * 5 Days a week * 52 Weeks. Seems simple, right? Its roughly how your annual salary is calculated (ROUGHLY.) — but because you’re no longer an employee with a set wage per month, this makes zero sense. Lets examine the reality on the ground.

There are ~260 work days in a year. Each year there are ~10 Federal holidays. Jane’s clients don’t expect work on those days and Jane probably doesn’t want to work them anyhow. She is now with 250 working days.

Now Jane’s at $250,000

Lets further assume Jane is sick a few times a year. Unlike employers who give paid sick days its all out of pocket for Jane at an average of 5 more days lost (I did research this. Answers were all over the place. I attempted to average it as best as I could from real life experience and research) — further Jane like a typical person would like vacation. As she’s an extra hard worker she only gives herself 7 full days off for vacation a year. She is now with 238 days of real work.

Now Jane’s at $238,000

Still you think that isn’t terrible she’s netting in $238,000! Except she’s not.

See billable hours are just that. Billable. (DunDunDun…)

There is plenty of stuff that is non billable. On average you can hope to bill 6 hours a day — exempting lunch and an hour for overhead duties (Sending emails, phone calls, administrative duties etc). Again this is roughly measuring you against your ‘8 hour’ work day. So now Jane is working 238 days of real work but only at 6 hours a day.

Now Jane’s at $178,500

It gets bleaker people. Jane’s employer kicked in for Social Security and Medicaid remember? Add on a whopping ~$10,500 in taxes (I beg forgiveness from the CPA’s reading. I know this is very back of the envelope math) that Jane never thought about needing to pay before.

Now Jane’s at $168,500

But wait you cry — she has an amazing salary compared to most of America still! She should be thankful she’s doing so well. Remember the non billable hours though! Keep in mind, this assumes Jane has managed to consistently find work for the 238 days she is working. That’s a steady stream of customers she’s on the hook for. There’s a ton of hours outside the 6–8 hour work day she may need to spend cultivating contacts, and managing expectations.

Don’t forget too other soft costs. Employer’s kick in a hefty amount for health insurance — something they already get cheaper than self-employed people. Let’s not forget the fact Jane also needs to buy her own equipment and no doubt pay more money for an accountant (Thank god for Tax Write Offs!).

I think everyone can see my point here. The hourly rate is a misnomer. Don’t assume because someone is charging you $100–200/hour they are going to be rolling around in a Maserati. Chances are they’re probably making half that in real dollars while dealing with the stress of being their own boss (a completely different topic) and beholden to the client

The bottom line? If you want a closer true salary, take your hourly rate * Real Billable Hours (6) * Real Work Days Per Year (238) and don’t forget to deduct the Medicare and Social Security (~$127,000 is the cut off for social security in 2017)

Freelancers — when just starting out remember these pitfalls! Don’t simply translate your annual salary to hourly. Add extra for the costs of being your own boss. There are a few other hidden ones I didn’t go into (Savings/401k, Rainy Day Fund, Business Insurance and so on…).

Clients — If you’re one of those who who complain about freelancer rates, take a moment to realize all the overhead they incur just like you. Simply because they freelance rather than work for an agency or as an employee doesn’t make them any less deserving of a fair rate considering their work in theory lets you keep your workforce smaller. Think of all the costs they save you (Payroll tax, recruitment fees, long term employee benefits etc).

Hopefully this article puts the costs of freelancing in a more realistic perspective for those thinking about it.