Freelance and contract workers: Understanding the ins and outs of compensation

What compensation structures are typical with different types of jobs? What are the pros and cons of being a freelancer? How do I calculate my freelance rate?

Quick snapshot

Beyond hourly and salaried is contractor status, meaning the individual worker is engaged by the company to do a defined project as an independent business or freelancer. Often, contract work is defined with a start and end date and also carries with it extensive definition around a scope of work (SOW) that establishes clear expectations around what the consultant will do, how they will engage with the organization, what they will produce as part of the engagement, and specific timing of the engagement’s major milestones. Sometimes, contractors will work with a business on an on-going basis beyond a single project or scope of work (think freelance designers, developers, IT support, and writers).  

Consulting workers are either paid based on an hourly rate and time worked or by the project. With this arrangement, the worker might have their own business as a sole proprietor or as a type of corporation or partnership, and effectively “bill” the employer for their time and sometimes materials based on the negotiated rate and other terms. In this case, the amount paid to the employee is the full amount of “compensation” and then the employee is obligated through their firm to work out what would have been the deductions—e.g., taxes owed, healthcare and other insurance costs). At the end of each year, the employer will issue a 1099 form to the contractor and the government to let them know that the consultant performed work for them and effectively indicating that they owe taxes for the consulting fees or compensation provided to them.

The benefit of consultants for employers is that they’re better able to ramp up or increase the amount of work when things are busy or there might be a unique project or need that the company doesn’t employ on regular basis. The arrangement also enables them to ramp down or decrease the human capital spend when things might not be as strong and/or the type of work isn’t necessary for the company’s ongoing business operations.

While some consulting projects might be short-lived and sort of a “one and done” effort, many others might be long-term and the consulting worker might end up looking more like a regular employee than a contractor. As the economy has evolved to be more services-based (vs. manufacturing), the volume of contract workers has increased. This change has been a positive one for both firms and workers looking to preserve their independence and gain a variety of jobs or projects that align with their specialty or area of expertise.

How to set your rate: By the hour  

There’s no denying that setting a freelance rate is hard, requiring you to answer a whole bunch of questions, from the profound (“Will they scoff at me if I ask for too much?” “Will they think less of me if I ask for too little?”  “What is my time worth?” “What am I worth?”) to the knotty and complex (“If I set this rate and get 45 hours of work one week but only 15 hours the next, will I be able to make rent this month?” “How much of this is going to taxes?” “Will I be able to afford health insurance?”).

Luckily, there are ways to set your hourly rate in a way that’s strategic and sound. We found a great method here from Creativelive. The basic gist is to first determine your target annual salary (for more on figuring out standard salary rates, check out our “Maximizing Your Compensation” post or see the links below). Then calculate your expenses (such as your computer, software, Internet, and cell phone bill) and your health insurance costs. Then add it all up, divide that number by your annual billable hours, and voila…there’s your hourly rate.

How to set your rate: By the project

Sometimes, organizations prefer not to pay contractors by the hour and will instead pay on a project-by-project basis (e.g., they’ll pay a set amount for a blog post, the development or design of a new website, etc.).

Before going into an agreement like this, make sure that your SOW is clearly defined. For example, if you’re hired to design a new website for a company, define how many rounds of feedback you will go through. That way if the company has feedback beyond the defined amount (let’s say, two rounds), you’ll be able to negotiate a new SOW when they send their third round of feedback. If you don’t go in with a clearly defined SOW, organizations can take advantage by making you go through countless iterations until they’re happy with the final result, meanwhile your “hourly rate” continues to lower the more hours you work.

So how do you determine your project rate? Figure out your hourly rate (see above) and then multiply that number by how many hours you estimate it will take for you to complete the project. This will involve a little trial and error at first (more likely than not, you’ll underestimate how much time a project will actually take), but once you have a few projects under your belt, you’ll get the hang of it.

Netting it all out

It’s tough to launch a freelance career. It means you’re always on the hunt, interviewing for new gigs, and networking your ass off. There might be months when you’re living without a steady paycheck and then months when you’re working three jobs at a time, 100 hours a week—because when new opportunities arise, it’s almost impossible to say “no.” Never again do you want to experience the freelance draught. So you say yes to everything that comes your way, even if it means you’re working too many hours, for projects you hate, for too little pay.  

One of the most difficult aspects of being a freelancer is that when you’re not working, you’re not getting paid. Sick time, vacation time, lunchtime, etc. are all unpaid. Not to mention the fact that your health insurance is nobody’s problem but your own. Plus, no one’s going to match your 401(k). And then there’s the tax thing—generally, organizations won’t take taxes out of your “paycheck,” which means when April comes, your bank account might take a massive hit.

But with all that said, life as a freelancer can also be massively awesome—a chance to gain tons of experience working with all sorts of interesting people on a wide range of projects. If you can handle the hustle, you’ll never get bored. Plus, the more you pitch yourself and tell your story, the better you’ll get at it, which will lead to more gigs, more confidence, and an upper hand if you ever decide you want a salaried role. And if you know how to budget your time and money, the flexibility of a freelance career is truly unrivaled. You’ll go to doctor’s appointments when everyone else is stuck at the office. You’ll take summer vacations without worrying about how many days you have left for the winter holidays. You’ll rarely if ever have to endure a time-sucking, soul-crushing commute. Instead, you’ll spend that time at the gym. And if you’re smart about setting aside money each month for taxes, come April you won’t feel a thing.

The Compensation Comparison:  Hourly vs. Salaried vs. Consulting Structures

Now that we have a basic understanding of each major category of worker, we wanted to provide a framework for netting out the various terms and conditions of each side-by-side to clarify the tradeoffs and make it easier to assess what might make the most sense for your unique situation.

What might make great sense at one stage of your life might make less sense at another. The key is to evaluate your priorities, your career goals, and the life you envision for yourself—in that moment and as a stop in your broader journey.

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About Alexis

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Alexis Harding is Women at Work’s resident HR expert. A long-time HR professional based in the Boston area, Alexis has rich experience in the HR departments of several large institutions over nearly two decades. She is here to engage with your questions about a range of topics that might be impacting your career and your overall success.

 

About Christina

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Christina Van Houten is the founder of Women at Work. Based in Boston with her husband and two teenage sons, she has spent the last 20 years of her career as a senior executive in the enterprise technology sector. Prior to evolving into tech, Christina founded a women's athletic apparel brand and served in several public interest roles focused on community and economic development. She started working at age thirteen and hasn't stopped since. She’s eager to help women find their way to the best possible life they can achieve.

 
 
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