Contract and Employee 101
10 Feb 2007 02:13 am![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
kaigouOh, man, do I feel like an idiot. Yesterday had a great interview, and clearly the manager adored me, but I waffled when we spoke at the end -- I didn't expect her to broach the subject of pay scale, not while I was still processing whether the intangibles of the job were worth less cash-in-hand. Naturally, today my mother calls out of the blue. I told her about the interview and my internal waffling over possible job with pay cut, and she says, "you do realize... don't you... that the conversion rate between contract position to employee position is thirty percent?"
So, I ran the numbers. And I'm listing them here because I know there are younger women on my flist, and you're going to be educated and armed, whether you like it or not.
For the sake of easy math, let's say a contractor makes 100,000 a year, so an equivalent employee position would be 70,000. Your first reaction is probably the same as mine: health insurance doesn't cost that much! It can, even without dependents+spouse (although some plans do cost more). The thing is: if you are trying to get individual (non-company-powered) health insurance... good luck. They can turn you down for any reason, or charge you a ridiculous amount. I just did some research for this area, and the "best rated" and "best deal" insurance? $281 a month with a $2,000 deductible. Cripes! Even seeing the doctor once a month and paying out-of-pocket for meds, and I spend maybe $200 past the deductible in one year.
That's not all, though. Employees get a lot more than just health insurance; there's retirement funds (whether pension or 401K or IRA), sick days, holidays, vacation days, flex spending plans, education reimbursement, and so on. The vast majority of those do not get taken out of your paycheck, or if some percentage is, the company often matches it. These are the hidden costs of being an independent contractor.
However, in the US, we can't compare apples to apples until we deal first with any pre-tax deductions from pay. (I don't know if other countries have this.) As a contractor, you're going to get the cash/check from the client, and either it'll be W2, or you'll go with a straight consulting amt from which you must pay quarterly taxes. Unless you have something special (and semi-expensive) set up, you'll probably just take all the income, taxed at regular rate, and then invest your savings. As an employee, this money, pre-tax, goes into savings (of whatever type), and isn't taxed and isn't counted as part of your taxable income.
I'm sure the basic concepts are known to most of you, but I don't know if you've ever done a breakdown on the way the numbers work out.
The second column, by row, contains: employee cost including estimated expenses for copays; contractor cost with purchased individual insurance plus estimated expenses for copays (in this case, none); contractor cost paying out-of-pocket for estimated expenses. The third column, by row, contains the cost of days off. I'm going with a roughly standard rule of "for every thirty days of work, you get a day of vacation and a day of sick leave, plus nine company-wide holidays" (like xmas, fourth of july, and then any company- or state-based holidays). Some places give you more, some less, but let's take that as a basic, since I'm too tired to go digging for an average. Now we need to assess how this changes when you figure in pre-tax costs, and see how this changes the tax base.
Okay, assuming the employee contributes 6% to a retirement fund or some kind of 401K, that means that of $70K annually, $4,200 will go into retirement. The actual take-home (and taxable) pay will thus be $65,800. Meanwhile, the contractor sets aside 6% to save, too, but this doesn't affect the taxable rate (the $6,000 in blue is part of the take-home pay). So the 'gross' column is the rate that gets taxed, and the 'taxes' column is how much Uncle Sam will want. The 'expense' column is from the graph above this one: the insurance/health costs, days off; the contractor's post-tax savings are added in here. That 'final' amount, above, is what's left, as the quasi 'take-home' pay, now that we have apples and apples.
But! There's another hidden value in here, which is that 99.9% of all companies out there will match the employee's contribution to whatever retirement or savings plan is available. That means the final series of columns in this row are:
Since the employee's company matches the 6% from the employee, that means the employee now has $8,400 in the bank/account/etc, while the contractor has $6,000. The column labeled $hr is the final take-home amount from the table above this one, divided by the number of working hours in the year. Not only does the employee now have more in the 'bank' (so to speak), but the employee managed it via deducting only $350 monthly. In contrast, the contractor deducted $500 monthly, has only $6K to show for it, and the actual per-hour take-home isn't significantly different the employee's!
But wait, it gets better. The next three rows in the graph above are the savings, hourly rate, and savings contributions if our three guinea pigs chose to contribute only two more percent out of the base salary. Now the poor contractor paying for full individual insurance is only pennies ahead of the employee, with the "pay-as-you-go" contractor only two dollars up -- yet the employee, after a year, would have over $11K in the bank, while the contractor just has $8K -- and the contractor had to deduct $200 more from each month's pay to get that.
Let's pretend both employee and contractor are really, really frugal, and they're all determined to invest as much as possible; in this case, 14% and 16%.
Red is for the employee's pre-tax contribution; blue is where the contractor's setting the money aside, while still being taxed at $100K income. Again, I don't know if this applies in other countries, but our lucky employee has now also hit another significant point: a drop from one tax bracket to the one below. Sweet. Between savings and tax rate, once you hit 18% contributions (and really, this could be to 401K, to a college fund for yourself or your children, to a Roth IRA, to a 467, there's actually a number of places it could go; what's important is it's going somewhere to be invested and you're not paying taxes on it), you can see life ain't so grand for our poor contractor trying to pay insurance -- and the contractor paying out-of-pocket is just barely keeping the lead against the employee.
So, lastly, what's that mean for savings?
The employee, at 16% and 18% matched contributions, now has $19,400 or $22,400 in the bank, respectively -- and that's after one year of deductions from the paycheck. Meanwhile, the contractor has $14K and $16K, but had to contribute $1,166 or $1,333, respectively, to get that much.
Even saying you only contribute a little extra, at 8%, to your retirement, let's extend that a bit further. Now, these are decent salary levels, so I'll go with age 35 as a starter (mostly because then it's exactly 30 years to retirement at age 65 and I like easy math).
If you put in $8,400, with an interest rate of 5.75% on the 401K, then at the end of the first year, you've got $8,883. That adds in with the next year, more interest, and by the 30th year, there's a max possible of $672,127. If you go up to 7.75% rate (a bit riskier portfolio to get bigger returns), the increase over thirty years is about 300,000; a little less if you contribute 8% instead, but at the safer 5.75% rate.
The kicker is here is whether it's a pension or a 401K, for those of you confused. A pension plan is not, I repeat, not, protected by law. You can contribute for forty years but if the company takes it away for whatever reason (see also: United Airlines, Enron) then that's just too bad for you. A 401K, however, cannot be stripped from you by your employer. Part of the reason for this is because a 401K is not administered by employers but by outside firms; pension plans are in-house. On the other hand, you could invest $10K annually in your 401K and the market just totally bombs -- and that year, instead of making $500 in interest, you lose $800. Yes, it happens.
A pension plan has no such risks. The pension plan's downstream benefits are independent of contribution; you put in your required percentage, it's matched by your employer, you work for X number of years to get 'vested' ...and when you retire, the company takes (usually) your highest-paid 36 months, runs that salary through some number crunching, and sets a pension amount. Then you get a check for that amount, regularly, for the rest of your life. You will never get less; you may get more, though, if it's a great year and the pension plan's investments do really well. When the bills are paid and sent off, if there's money left over in the kitty, all the current retirees get a bonus that year.
Note: a pension plan has few risks, but it also means you stand to gain nothing from investing even a penny more than required by the company. In contrast, a 401K is entirely optional; you could skip it altogether, or invest up to X amount (currently 15% of your income, I think). Plus, you could gain a great deal from investing more, or you could just lose more if you select riskier -- but higher-rated -- investment/mutual funds to sink your 401K money into.
The upshot? If you're stuck with a pension plan, you don't give a damn what the market's doing while you're employed, but you want it to be massively vigorous once you've retired. If you have a 401K, you want a happy market while you're employed, and then -- when you're living off your savings upon retirement, you could probably care far less about the market except to be as frugal and cautious as possible.
I mean, that's what the blue numbers are for: assuming you live another 30 years after retirement, that almost-a-million is really only $32K a year -- and that's assuming you could get a relatively consistent 7.75% for thirty years. (It's also assuming your income remained flat all that time, but I wasn't going to complicate it too much further.) Almost a million looks like a lot of money, except that (a) you may end up having to make it stretch for yourself, your partner, possibly desperate grown children who are in one strait or another, maybe a nursing home, hospital bills, and (b) with a 401K, you don't necessarily have a guarantee that you'll make that much consistently to add to it. And (c), of course, is that you can't even touch it pre-retirement-year without incurring some major taxes/penalties. There are exceptions, like if your house burns down, but even then, you get a loan off your retirement fund (which is really just "here, have some of your own money"), and if you don't pay it back into the fund, you have to pay the penalties. Just so you don't think it's the exact same as a simple savings account.
So just for kicks, let's see how our contractor's doing with saving for retirement via, perhaps, a Roth IRA (another retirement tax-shelter):
Sorry to make you scroll up and back to compare this guy with the employee, but let me assure you: it don't look too good for our contractor. That social security check is sure gonna come in handy...
Of course, this is all ignoring that life never goes as planned. If you have insurance, then an unexpected doctor's visit won't set you back more than, say, the $100-per-day hospital deductible if you have to go in for emergency surgery. If you have sick and vacation time, and you're out with double pneumonia and end up missing two and a half weeks of work, your pay isn't docked; most likely, you'll go into the red and HR will make nasty comments about no more days off until you work your way out of the hole.
And even if you go over the limit of 'negative hours', many places have 'sick leave pools,' where people who've not used their sick time can donate it to the pool on behalf of a coworker who needs it; last contract I had, a call went out for anyone donating to the pool on behalf of a woman whose daughter had been in the hospital for a week... and then the woman's mother died, and she had no time left to fly wherever for a week to deal with the funeral. You certainly don't get that as a contractor. Instead, what here looks like X amount of money is, in fact, simply 'days you don't get paid'. There's a definite lack of security in that, and few contractors (myself included) are the kind to knock money out of our paychecks to set aside as 'self-paying vacation days' when needed.
The upshot, obviously, is that Mom was right (as usual, when it comes to HR stuff). And also, that I feel like a damn fool for not knowing/realizing this earlier, so i could say after the interview, all smiles, "but this isn't a cut in pay at all, this is actually a 10% increase!"
So, I ran the numbers. And I'm listing them here because I know there are younger women on my flist, and you're going to be educated and armed, whether you like it or not.
For the sake of easy math, let's say a contractor makes 100,000 a year, so an equivalent employee position would be 70,000. Your first reaction is probably the same as mine: health insurance doesn't cost that much! It can, even without dependents+spouse (although some plans do cost more). The thing is: if you are trying to get individual (non-company-powered) health insurance... good luck. They can turn you down for any reason, or charge you a ridiculous amount. I just did some research for this area, and the "best rated" and "best deal" insurance? $281 a month with a $2,000 deductible. Cripes! Even seeing the doctor once a month and paying out-of-pocket for meds, and I spend maybe $200 past the deductible in one year.
That's not all, though. Employees get a lot more than just health insurance; there's retirement funds (whether pension or 401K or IRA), sick days, holidays, vacation days, flex spending plans, education reimbursement, and so on. The vast majority of those do not get taken out of your paycheck, or if some percentage is, the company often matches it. These are the hidden costs of being an independent contractor.
However, in the US, we can't compare apples to apples until we deal first with any pre-tax deductions from pay. (I don't know if other countries have this.) As a contractor, you're going to get the cash/check from the client, and either it'll be W2, or you'll go with a straight consulting amt from which you must pay quarterly taxes. Unless you have something special (and semi-expensive) set up, you'll probably just take all the income, taxed at regular rate, and then invest your savings. As an employee, this money, pre-tax, goes into savings (of whatever type), and isn't taxed and isn't counted as part of your taxable income.
I'm sure the basic concepts are known to most of you, but I don't know if you've ever done a breakdown on the way the numbers work out.
The second column, by row, contains: employee cost including estimated expenses for copays; contractor cost with purchased individual insurance plus estimated expenses for copays (in this case, none); contractor cost paying out-of-pocket for estimated expenses. The third column, by row, contains the cost of days off. I'm going with a roughly standard rule of "for every thirty days of work, you get a day of vacation and a day of sick leave, plus nine company-wide holidays" (like xmas, fourth of july, and then any company- or state-based holidays). Some places give you more, some less, but let's take that as a basic, since I'm too tired to go digging for an average. Now we need to assess how this changes when you figure in pre-tax costs, and see how this changes the tax base.
Okay, assuming the employee contributes 6% to a retirement fund or some kind of 401K, that means that of $70K annually, $4,200 will go into retirement. The actual take-home (and taxable) pay will thus be $65,800. Meanwhile, the contractor sets aside 6% to save, too, but this doesn't affect the taxable rate (the $6,000 in blue is part of the take-home pay). So the 'gross' column is the rate that gets taxed, and the 'taxes' column is how much Uncle Sam will want. The 'expense' column is from the graph above this one: the insurance/health costs, days off; the contractor's post-tax savings are added in here. That 'final' amount, above, is what's left, as the quasi 'take-home' pay, now that we have apples and apples.
But! There's another hidden value in here, which is that 99.9% of all companies out there will match the employee's contribution to whatever retirement or savings plan is available. That means the final series of columns in this row are:
Since the employee's company matches the 6% from the employee, that means the employee now has $8,400 in the bank/account/etc, while the contractor has $6,000. The column labeled $hr is the final take-home amount from the table above this one, divided by the number of working hours in the year. Not only does the employee now have more in the 'bank' (so to speak), but the employee managed it via deducting only $350 monthly. In contrast, the contractor deducted $500 monthly, has only $6K to show for it, and the actual per-hour take-home isn't significantly different the employee's!
But wait, it gets better. The next three rows in the graph above are the savings, hourly rate, and savings contributions if our three guinea pigs chose to contribute only two more percent out of the base salary. Now the poor contractor paying for full individual insurance is only pennies ahead of the employee, with the "pay-as-you-go" contractor only two dollars up -- yet the employee, after a year, would have over $11K in the bank, while the contractor just has $8K -- and the contractor had to deduct $200 more from each month's pay to get that.
Let's pretend both employee and contractor are really, really frugal, and they're all determined to invest as much as possible; in this case, 14% and 16%.
Red is for the employee's pre-tax contribution; blue is where the contractor's setting the money aside, while still being taxed at $100K income. Again, I don't know if this applies in other countries, but our lucky employee has now also hit another significant point: a drop from one tax bracket to the one below. Sweet. Between savings and tax rate, once you hit 18% contributions (and really, this could be to 401K, to a college fund for yourself or your children, to a Roth IRA, to a 467, there's actually a number of places it could go; what's important is it's going somewhere to be invested and you're not paying taxes on it), you can see life ain't so grand for our poor contractor trying to pay insurance -- and the contractor paying out-of-pocket is just barely keeping the lead against the employee.
So, lastly, what's that mean for savings?
The employee, at 16% and 18% matched contributions, now has $19,400 or $22,400 in the bank, respectively -- and that's after one year of deductions from the paycheck. Meanwhile, the contractor has $14K and $16K, but had to contribute $1,166 or $1,333, respectively, to get that much.
Even saying you only contribute a little extra, at 8%, to your retirement, let's extend that a bit further. Now, these are decent salary levels, so I'll go with age 35 as a starter (mostly because then it's exactly 30 years to retirement at age 65 and I like easy math).
If you put in $8,400, with an interest rate of 5.75% on the 401K, then at the end of the first year, you've got $8,883. That adds in with the next year, more interest, and by the 30th year, there's a max possible of $672,127. If you go up to 7.75% rate (a bit riskier portfolio to get bigger returns), the increase over thirty years is about 300,000; a little less if you contribute 8% instead, but at the safer 5.75% rate.
The kicker is here is whether it's a pension or a 401K, for those of you confused. A pension plan is not, I repeat, not, protected by law. You can contribute for forty years but if the company takes it away for whatever reason (see also: United Airlines, Enron) then that's just too bad for you. A 401K, however, cannot be stripped from you by your employer. Part of the reason for this is because a 401K is not administered by employers but by outside firms; pension plans are in-house. On the other hand, you could invest $10K annually in your 401K and the market just totally bombs -- and that year, instead of making $500 in interest, you lose $800. Yes, it happens.
A pension plan has no such risks. The pension plan's downstream benefits are independent of contribution; you put in your required percentage, it's matched by your employer, you work for X number of years to get 'vested' ...and when you retire, the company takes (usually) your highest-paid 36 months, runs that salary through some number crunching, and sets a pension amount. Then you get a check for that amount, regularly, for the rest of your life. You will never get less; you may get more, though, if it's a great year and the pension plan's investments do really well. When the bills are paid and sent off, if there's money left over in the kitty, all the current retirees get a bonus that year.
Note: a pension plan has few risks, but it also means you stand to gain nothing from investing even a penny more than required by the company. In contrast, a 401K is entirely optional; you could skip it altogether, or invest up to X amount (currently 15% of your income, I think). Plus, you could gain a great deal from investing more, or you could just lose more if you select riskier -- but higher-rated -- investment/mutual funds to sink your 401K money into.
The upshot? If you're stuck with a pension plan, you don't give a damn what the market's doing while you're employed, but you want it to be massively vigorous once you've retired. If you have a 401K, you want a happy market while you're employed, and then -- when you're living off your savings upon retirement, you could probably care far less about the market except to be as frugal and cautious as possible.
I mean, that's what the blue numbers are for: assuming you live another 30 years after retirement, that almost-a-million is really only $32K a year -- and that's assuming you could get a relatively consistent 7.75% for thirty years. (It's also assuming your income remained flat all that time, but I wasn't going to complicate it too much further.) Almost a million looks like a lot of money, except that (a) you may end up having to make it stretch for yourself, your partner, possibly desperate grown children who are in one strait or another, maybe a nursing home, hospital bills, and (b) with a 401K, you don't necessarily have a guarantee that you'll make that much consistently to add to it. And (c), of course, is that you can't even touch it pre-retirement-year without incurring some major taxes/penalties. There are exceptions, like if your house burns down, but even then, you get a loan off your retirement fund (which is really just "here, have some of your own money"), and if you don't pay it back into the fund, you have to pay the penalties. Just so you don't think it's the exact same as a simple savings account.
So just for kicks, let's see how our contractor's doing with saving for retirement via, perhaps, a Roth IRA (another retirement tax-shelter):
Sorry to make you scroll up and back to compare this guy with the employee, but let me assure you: it don't look too good for our contractor. That social security check is sure gonna come in handy...
Of course, this is all ignoring that life never goes as planned. If you have insurance, then an unexpected doctor's visit won't set you back more than, say, the $100-per-day hospital deductible if you have to go in for emergency surgery. If you have sick and vacation time, and you're out with double pneumonia and end up missing two and a half weeks of work, your pay isn't docked; most likely, you'll go into the red and HR will make nasty comments about no more days off until you work your way out of the hole.
And even if you go over the limit of 'negative hours', many places have 'sick leave pools,' where people who've not used their sick time can donate it to the pool on behalf of a coworker who needs it; last contract I had, a call went out for anyone donating to the pool on behalf of a woman whose daughter had been in the hospital for a week... and then the woman's mother died, and she had no time left to fly wherever for a week to deal with the funeral. You certainly don't get that as a contractor. Instead, what here looks like X amount of money is, in fact, simply 'days you don't get paid'. There's a definite lack of security in that, and few contractors (myself included) are the kind to knock money out of our paychecks to set aside as 'self-paying vacation days' when needed.
The upshot, obviously, is that Mom was right (as usual, when it comes to HR stuff). And also, that I feel like a damn fool for not knowing/realizing this earlier, so i could say after the interview, all smiles, "but this isn't a cut in pay at all, this is actually a 10% increase!"
![[identity profile]](https://www.dreamwidth.org/img/silk/identity/openid.png){kind=small}
no subject
Date: 10 Feb 2007 03:24 pm (UTC)And yes, when he retires we'll have (if all goes well) over a million in our investments, but like you said, spread over 20 years or more it isn't really all that much.
no subject
Date: 10 Feb 2007 05:58 pm (UTC)Not to mention the tax shelters of education trust fund, and a few others, too. Probably some long-term funds, like the 13-month deposit we did last year, which had a nice 5% return. The one limit was not being able to touch the $ for 13 months, but the risk was almost nil.
And honestly, I never did a 401K -- at all! -- even when corporate because no one really ever sat me down and *explained* why it was so important, and how little money it means in terms of your everyday paycheck and how much it matters in the long run. I'd always just gone with "savings account" at my credit union, and the return on that is only like 4%, approximately. Sigh.
no subject
Date: 10 Feb 2007 04:28 pm (UTC)no subject
Date: 11 Feb 2007 08:46 am (UTC)I told her: if the Beltway Bandit HR had had any clue about this, when I'd called to complain about the offer letter, they should've said, "here, how about you sit down and we explain to you that in getting X more thousand dollars, you're in fact getting nearly a 40% raise."
Believe me, I would've shut the hell up right then, and that might possibly have prevented at least one of the biggest conflicts between my boss and me. Perhaps it would've only been stalling the inevitable, but at least I wouldn't have felt quite so strongly that I was being gouged. I would've had it on paper the intangible benefits, and how it added up.
My mom's response: "Of course they didn't even think to do that, but then, they're not industrial psychologists with training in statistics... who have a husband who understands break-even points!"
*snerk*
insurance
Date: 11 Feb 2007 05:31 am (UTC)Also when you're looking at a company, you have to look at the benefits. I don't get paid a lot working for UMass Boston, but I have good benefits, which include free classes up to a PhD. And I'm not part of Social Security, so I might acually get something when I retire. I also sock a lot away into retirement with a 401k.
DK
PS> you really don't want to know how much paid time I get off ;-)
no subject
Date: 11 Feb 2007 08:51 am (UTC)In fact, the agency I've been interviewing with pays for the employee's insurance 100% (not counting usual mild copays). What I can't figure out is that adding a spouse costs $230/mon, while opting out of insurance only gets $60 added (and that has to be spent on Dental or AD&D, say what?). Numbers aren't adding up there, or it's possibly their intention to dissuade spouses from jumping on the plan if an alternate's available.
Vacation/sick? I'm still boggling: 8hrs sick + 8hrs vaca, per month (okay, normal enough) ... and fourteen holidays a year. Holy crap. I think I checked that line at least five times, because that's just... damn. The one thing I've not figured out is whether there's any accrual in terms of "if you've been here three years..." and so on. But I'll be talking to an HR generalist on Monday, so we'll see.
no subject
Date: 11 Feb 2007 04:53 pm (UTC)Do you get personal days too?
I get sick time, vacation time, personal days (6) and holidays (12).
I've been at U/Mass for 11 years and have a ton of sick time accrued.
As to adding the spouse on the insurance, they're covering you, which might be costing them a lot of money, so adding a spouse will cost them more money. And is it spouse or family? DINKS get screwed on that because the system believes that you're going to have kids and charges yuo accordingly.
And how good is the insurance? The bigger the company, the better the package.
DK
no subject
Date: 12 Feb 2007 01:22 am (UTC)But I've also worked places where it's all together as "Full Time Off" and other places that broke each out and heavens forbid you think to use a sick day as a vacation day, oh, no!
That $230 is just for spouse -- it's $350 for spouse+family. (Oddly, for employee+1 child, it's back to $230; that's a variation you don't see often.) Still not keen on paying that much money for insurance, but I suspect if their coverage is so awesome, they're doing the same as the Beltway Bandit did, which was to push people into not covering spouses (who might be covered elsewhere) and thus send up premiums for employees overall.
Actually, at the Beltway Bandit, to cover a spouse, you had to fill out a form verifying that spouse couldn't get coverage from his/her own job, or had no job to provide coverage. Sheesh.
no subject
Date: 12 Feb 2007 02:55 am (UTC)no subject
Date: 12 Feb 2007 03:24 am (UTC)The concept of pay-in savings plans used to offset otherwise out-of-pocket costs aren't new; in fact, the Beltway Bandit I'd considered had that as an option for health insurance. It's used most frequently in areas where a national (or international) corporation's primary health insurance plan doesn't dominate, thus putting employees in the bizarre situation of having to pay for 'out of area' service.
The drawback of a savings-health plan is that you don't get the benefit of insurance-adjusted costs; for instance, when I had an emergency hospital visit, I would've owed roughly $700 (and that's with no tests run!). But once the bill was adjusted for insurance agreements, it dropped to $400 (the maximum allowed, not counting tests or surgery), and then dropped again by virtue of the no-copay-for-emergency agreement my company had with the insurance company. As I understood it, the savings-health would've paid the $700, true, but that's $700 that I didn't have to pay at all with the traditional primary care option.
There are health insurance programs for professionals who otherwise have none: small businesses, writers, stylists, artists, who by combining into a large organization are able to pull weight similar to any big company. I would still recommend those over savings-health plans, from what I understand of the latter.
Of course, that also depends on region, needs, and estimated expenses, so YMMV.