The true cost of employees: How much does an employee *really* cost?
Table of Contents
Employers pay more than just the salaries of their employees. Explore the main variables to help calculate the actual annual cost of your workforce.
How much does an employee cost? This article addresses some of the basic considerations you need to know when hiring someone in the private sector in the United States (some of the things that you will find here are easily adaptable to other countries, like social security related expenses).
Our case is based on salaried employees as opposed to hourly rate workers. While many employers and institutions (including the Bureau of Labor Statistics of the U.S. Department of Labor) prefer to work around hours rather than salaries, we have opted for the latter to give you a better idea of the real annual costs of your employees.
Simple formulas to calculate the cost of your employee
Calculating your labor rates is a complex exercise that requires a careful examination of different variables like the industry you belong to, the type and characteristics of the role you are planning to cover, the location of your company, and the kind of benefits and legal expenses you are willing and required to pay for that employee. While this may be intimidating at first, there are some basic variables that will always affect your labor rates. We will explore those variables so you can better calculate the potential costs posed by a new hire.
What needs to be added to base salary?
Let’s start with Joe Hadzima, a Senior Lecturer at MIT who provides a simple formula to calculate the actual cost of an employee. According to Hadzima, once you have taken into consideration basic salary, taxes and benefits, the real costs of your employees are typically in the 1.25 to 1.4 times base salary range. In other words, an employee earning $30,000 will cost you somewhere between $37,500 and $42,000.
Similarly, and while trying to answer the question “How much does an employee really cost?,” CNN’s reporter Jose Pagliery said that the real salary of an employee ends up “being 18% to 26% more than a worker’s base salary.” That said, let’s take the formulas we have just mentioned and see how they work for specific salaries:
|How much should I pay for an employee?|
|Employee’s base salary||Real annual cost per employee
Hadzima (1.25 to 1.4 times of base salary)
|Real annual cost per employee
Pagliery (18% to 26% more than base salary)
As we can see, the two formulas provide similar numbers that we can take as an idea of the potential cost of a new hire. However, we will now explore the basic ingredients you need to know in order to calculate your labor costs. We will come back to these numbers to see how they compare with our findings.
Factors that affect base salary
The base salary is affected by some of the factors we mentioned at the beginning of this article. Location, for instance, affects salaries in a decisive way even if we are considering the same role. Costs of living are the main drive, as you can see from the following chart we created using the cost of living calculator from CNNMoney.
|From / To||Miami||San Antonio||New York||Denver||San Francisco|
Based on the above, if you live in Miami with a salary of $40,000, a comparable salary in Manhattan would be around $83,322 just because the costs of living in New York City are much higher than in the Miami-Dade County area. However, a comparable salary in San Antonio, Texas, where the cost of living is lower than Miami, would be around $30,769. Again, this calculator is useful in terms of providing an indication of how your salary will compare in different cities across the country taking into consideration things like housing, groceries, utilities, transportation, and health care.
What factors affect base salary?
- Industry sector.
- Demand of professionals and skills in the market.
- Education and experience (qualification).
- Company size.
- Job tasks.
- Success and performance.
Sometimes, a combination of those factors can create huge salary differences even among people with the same role. The following chart based on the percentiles and wages differences illustration from the Bureau of Labor Statistics exemplifies this issue for commercial pilots.
|Percentile wages and wage difference
for commercial pilots, May 2014
|10th percentile (10% made less, 90% made more||50th percentile: Median (50% made less, 50% made more)||90th percentile (90% made less, 10% made more|
|Wage difference between 10th percentile and 90th percentile: $105,960|
The binding costs you need to cover
Every employer in the U.S. needs to pay taxes and unemployment insurance for their employees. Companies are required by law to cover social security, Medicare as well as state and federal taxes. Let’s see in detail.
1. FICA (Federal Insurance Contributions Act)
This mandatory payroll deduction serves to cover Social Security and Medicare. The employer needs to cover 6.20% for Social Security and 1.45% for Medicare.
2. FUTA & SUTA (unemployment insurance)
Employers need to pay for both the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). As far as FUTA goes, companies are only required to pay 6% of taxes for the first $7,000 earned by any employee. That said, most companies will pay $420 annually to cover federal unemployment. The only exception to that rule is California, where companies need to pay 2.1% or $147 annually.
On the other hand, SUTA (sometimes also referred to as SUI – State Unemployment Insurance) is calculated in a different way and can change significantly across states. Generally speaking, however, SUTA oscillates between 2.7% and 3.4%.
3. Workers’ Compensation Insurance
In order to insure employees against injuries, every employer needs to pay for workers’ compensation. Considering that risks are highly different among industries and specific jobs, this cost varies a lot. To calculate workers’ comp, each type of job is covered with a specific rate for every $100 of salary. The following numbers from the National Council on Compensation Insurance (NCCI) illustrate how workers’ comp is calculated across different jobs:
|Description||Class code||Rate per $100||Base salary||Cost/Employee|
If you notice, workers’ comp for jobs where injuries are more common is a lot higher. Having said that, we can figure out now how much an employer needs to pay for Social Security, Medicare, federal and unemployment insurance and workers’ comp. Let’s see the details in the following chart, assuming a 3% rate of SUTA and $0.12 for workers’ comp:
|Type of cost||Percentage of employee’s base salary||Base salary $30,000||Base salary $70,000|
|FICA Social Security||6.2%||$1,860||$4,340|
|Unemployment insurance FUTA||6% of first $7,000||$420||$420|
|Unemployment insurance SUTA||2.7%-3.4%||$900||$2,100|
|Workers’ Comp||$0.12 for each $100 of wages||$36||$84|
Now that we understand this, let’s see some of the standard benefits that employees usually get in the private sector.
The regular benefits most employers are willing to provide
Besides Medicare, most companies offer private health insurance to their employees. In fact, health insurance represents the highest cost of all benefits. According to data discussed by Joe Hadzima, health insurance for an employee making $50,000 a year will cost between $2,000-$3,000 (single employees) and $6,000-$7,000 (for families). Similarly, Christina Merhar, Senior Editor for Zane Benefits, states that the yearly amount an employer pays for health insurance in the U.S. runs between $5,000 and $12,000.
Besides health insurance, many companies also offer life insurance (around $150 on the first $50,000 of your wages) and long term disability insurance (approximately $250 per year). Next to all this, dental insurance is one of the most popular benefits in the private sector.
In general, the cost of dental insurance varies depending on factors like the number of employees, the type of coverage provided and the location of your business. Generally speaking, dental insurance premiums cost somewhere between $25 to $50 a month, an estimate that fits into the annual cost of $240-$650 that Joe Hadzima assigns to dental insurance.
After health-related insurance, many employers are also willing to cover additional benefits like 401(k) plans, personal devices (laptops, cell phones) and vehicle costs. As far as 401(k) goes, Jose Paglieri states that the “average contribution to 401(k) plans is 2.5% of a worker’s salary.”
Let’s see how all the benefits we have mentioned look for employees with base salaries of $30,000 and $70,000. To give you a better idea, we have picked a specific amount for each cost:
|How much does an employer pay for benefits?|
|Health insurance ($5,000/12,000)||$7,000||$7,000|
|Life insurance ($150 on $50,000)||$150||$150|
|Long term disability insurance ($250)||$250||$250|
|401(k) (2.5% of salary)||$750||$1,750|
Arriving at the total cost of your employee
At this point, we have all the variables we need to calculate the annual cost of an employee. Now, we just need to add everything and see what we get. Let’s take a look at the following chart:
|Annual cost of an employee|
|Total FICA, FUTA, SUTA and workers’ comp||$3,651||$7,959|
|Total annual cost||$42,251||$87,559|
According to our findings, we would need to pay $42,251 for an employee with a base salary of $30,000, which means we need to add to that base salary $12,251 to cover taxes and benefits. That amount is about 40% of the total annual cost, which is pretty close to the upper end that Hadzima ($42,000) estimates for a base salary of $30,000. Pagliery’s higher end ($37,800) is way below that number.
On the other hand, the real annual cost of someone with a base salary of $70,000 would be around $87,559, which means a percentage of 25% of total compensation in taxes and benefits to pay for that employee. That number is almost equal to the lower end of Hadzima’s range ($87,500) and a bit below Pagliery’s higher end ($88,200), which confirms the fact that the higher the salary, the lower the percentage employers end up paying on top of the base salary.
How to use employee costs to understand and optimize your business
Accurately calculating employee cost is not just a good hiring practice, it’s an essential budgeting task. Once you have a clear idea of each employee’s costs, this data can be integrated into your business intelligence tools, helping you to effectively track and budget projects and clients. BeeBole’s Standard Cost module, for example, allows you to assign an hourly cost for each employee, which will then be used in the tool’s reports on budgeting and profitability.
Why is this important to companies using tools like ours? Because managers can monitor the costs and profitability of certain clients or projects in real time to ensure they never go over budget, and identify where the money sucks are. Of course, in order to reach an hourly figure you’ll first need to use our tips from above to calculate the total cost for that employee.
Insights gained from incorporating employee costs into your business intelligence is sure to save you time and money in the long run.
Furthermore, having a clear understanding of everything that goes into maintaining an employee may change the way you look at your human capital. Nevertheless, while substantial, these costs shouldn’t be viewed as an unfair burden on your company, as investing in your workforce is key to sustaining a successful business.
Please let us know your thoughts. Any suggestions, corrections? Thank you!
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