How to calculate contractor day rate from salary?

One question that arises regularly, especially from people looking to move into contracting, is -- how do I compare a contract’s day rate to my current salary? And vice versa, should you already be a contractor trying to decide about a move to full-time work.

The problem is; writes Alan Watts, a service management consultant (retired), with more than 40 years’ experience as an IT contractor, this simple, albeit two-way question has a very complicated answer with several variables in play!

If pay simplicity matters, work direct as an employee…

If you are an employee, you will have an easily understood annual salary, making comparisons between other salaried roles straightforward. Your payslip will show you how much is getting deducted each week or month and why. You may also get other allowances, such as a company car or rail fare allowances, ‘London weighting’ and the like.

At the end of the day (literally), you will have a good idea how much of your headline salary will end up in your bank account every month.

Salary inflators

What you may not notice is how much money is added to your salary by your employer. They have National Insurance to pay as well, but they also have costs associated with your employment. It’s a long list, but includes taxes, accommodation, equipment and tools, HR support, training and the like.

This increases your salary considerably – at least 50% in most cases, and often, for more senior roles, a lot more zero -- giving your actual cost of employment. And that total sum for you as an employee is what you need to compare to your contract rate. It is also the number that the client will use when deciding the equivalent day rate for a contractor (assuming they don’t simply divide the pay scale amount by 260 days a year, as some do).

Working from your contract day rate to work out salary

Looking at comparisons from contract income, the picture is different and depends on whether you are using your own company or, for one reason or another, are through an umbrella company / agency payroll.

For the latter, the contract payment from the client is subject to various deductions. Each of the companies between you and the end-client will have their deductions, such as any agency margins and your pension contributions. The remainder will be taxed in full and you get the resultant net amount.

The point of comparison

Some of those deductions will not be all that transparent (margins are often concealed for commercial reasons), so you need to be clear on what the difference between the headline rate advertised -- and the actual one that you will be taxed on. That then is your point of comparison to a full-time salary.

If you have your own company, it’s a lot clearer. You will get a payment from the client and you decide how much of it you pay yourself, and how much stays in the company for future use. Your pay is usually split between a tax-efficient salary and some level of dividend payments as your profits allow.

Variations, factors, expenses

As a contractor, other factors will impact that calculation such as pensions savings and operating costs, none of which are the concern of the salaried employee and all of which will vary from one person to the next.

Similarly, expenses are a factor. Employees, after all, are usually in easy reach of their place of work whereas you have to get to where the work is. You should keep track of all the sums involved and deduct all the necessary taxes and costs, leaving you with a net income. You don’t even have to take the same amount every month but look at it as an annual exercise and plan accordingly.

Be careful with calculators

So a comparison between a salary and a contract is possible -- but there is a lot more to be considered than simply deriving a net income per month from the gross.

There are online calculators that will attempt to do just that, and while they will probably give a close guess on the tax overhead, it is certain they will not allow for your personal circumstances and how many days a year you actually get paid.

Finally, in a rush? Just halve it, or estimate two-thirds

Without all the above analysis, the best you can do -- especially if you need a quick answer -- is take the offered day rate and halve it if you work through an umbrella, or assume you get two-thirds of it through your own company, to get a rough net pay, although that still assumes you will be earning for the whole year. Which you probably won’t be. Good luck, and if in doubt crunch the numbers with an accountant or someone similarly financially shrewd who knows your circumstances!