Let’s play out a hypothetical scenario: you have a new project that will take exactly one year to build and launch, and there are two development options you’re considering:
- Hire a full-time (w2 employee) software engineer with a base salary of $150,000 per year
- Hire a senior freelancer for $150/hour, 40 hours/week, and 49 weeks/year
While the total cost of a freelancer is simple to calculate, the cost of the full-time employee is more nuanced. Here are some overlooked cost considerations for the FTE:
Recruiting and Training Costs
Recruiting is costly because it takes time. Whether it’s your time or someone else’s, it is a meaningful cost. Per Investopedia, recruiting includes “advertising the opening, the time cost of an internal recruiter, the time cost of a recruiter’s assistant in reviewing resumes and performing other recruitment-related tasks, the time cost of the person conducting the interviews, drug screens and background checks, and various pre-employment assessment tests.”
In addition, training is a major cost, per entrepreneur Scott Allen:
“Calculate the cost of both structured training (including materials) and the time of managers and key coworkers to train the new employee to the point of 100% productivity.”
A study by the Society for Human Resource Management (SHRM) states that employers will need to spend the equivalent of six to nine months of an employee’s salary in order to find and train their replacement.
According to that study, then, a salaried employee at $150,000 will cost the company anywhere from $75,000 to $112,500 to hire and train a replacement. As a conservative estimate, we’ll use $100,000 as the cost of recruiting, hiring, and training this particular individual.
Tax Considerations for FTEs
- Payroll Tax: 15% of the employee’s salary
- Social Security: 6.2% on each employee’s wage up to $118,500
- Federal Unemployment Insurance: 6% on first $7,000 of employee’s wages
- Workers’ Compensation: On average about 1.85% of employee’s wages
- Medicare: 1.45% of the employee’s salary
A salaried employee at $150,000 will cost $22,500 in payroll tax.
On top of that, keeping track of expenses for FTEs is complicated, so if you don’t have an accountant already, and it makes sense for your company, you might want to consider hiring one.
Paying Severance for FTEs
Severance or other termination costs vary for employees based on how long they’ve been at the company, their title, and what they negotiated in their employment agreement. In the hypothetical scenario we’ve proposed, we’ll overlook severance as a cost. But the reality is that for FTEs, severance can range from weeks to more than a year of pay for FTEs after they depart. McKinsey is currently in the midst of laying off 2,000 employees, and employees can get up to 24 months of severance pay.
Freelancers, on the other hand, require zero severance payments.
The Cost of Employee Benefits
Hiring a full-time employee requires paying for their benefits. These typically include health insurance, life insurance, dental insurance, and other perks. Below is a list of the most common benefits and their average annual costs:
- Health coverage: $5,000 to $20,000
- Life insurance: $100-$300
- Dental insurance: $500-$2,500
- Disability insurance: $250-$1,500
- Retirement savings: 3% of $150,000 = $4,500
That means for an FTE with a $150,000 salary, the cost of benefits ranges from $10,350 to $28,800. For the purposes of this analysis, we’ll average it out at $20,000.
Lost Time and its Associated Costs
For FTEs, let’s assume 3 weeks of paid vacation and 5 paid sick days per year. That’s 7.7% of the full work year, which means right off the bat, your full-time employee will be paid for 7.7% of the work year while out of the office. At an annual salary of $150,000, that’s $11,550 going to vacation and sick time.
Freelancers may take vacation or sick days, but your company wouldn’t pay for that time.
Office Space and Equipment Costs
Furnishing the office, providing physical space, and providing the proper technological equipment (laptop, phone, etc.) all add up. With office space averaging between $300-$1,230 per month and per employee, we are spending anywhere from $3,600 to $14,760 per full-time hire for the whole year.
Even companies that have gone remote or are embracing a hybrid policy still spend money on their employees’ equipment. In fact, many have opted to give their employees work-from-home stipends, money that employees receive in addition to their base salaries. Work-from-home stipends are an attractive and sometimes legally mandatory benefit for remote employees, with average total stipends typically ranging between $250-$2,500.
As a conservative estimate, we’ll use $6,500/year as the prorated cost of office space and equipment for a full-time hire (assuming $500 per month on office space and a $500 total stipend).
The Final and True Potential Cost Difference
Nothing exists in a vacuum, and there are other things to consider when choosing between an FTE and a freelancer. However, the point of this article is to demonstrate the sometimes overlooked costs associated with full-time employees, in contrast to the simple terms associated with freelancers.
Here’s the final tally taking most considerations (excluding severance or other termination costs) into account:
- Hire a full-time, senior software engineer for $150,000 per year:
- Base salary: $150,000
- Recruiting and training: $100,000
- Payroll tax: $22,500
- Insurance & other benefits: $20,000
- Lost time: $11,550
- Office space/ equipment / remote-work stipend: $6,500
- TOTAL COST ⩰ $310,550 in Year One
- Hire a senior freelancer for $150/hour, 40 hours/week, 49 weeks/year
- $150 / hour x 40 hours / week = $6,000 / week
- $6,000 / week x 49 weeks = $294,000
- TOTAL COST ⩰ $294,000 in Year One
Using these cost differences, businesses can make an informed decision about which development option best suits their needs. From a strictly quantitative perspective, it’s not as simple as, “a full-time employee would cost me $150,000 but a freelancer at $150/hour is more expensive over time.” The hiring process isn’t as cut-and-dry as a single number. But by considering all the factors, businesses can make a decision that saves them money in the long run and helps them achieve their project goals.