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When I started doing contract work, on the side, I was shocked by how much more I made from that side hustle than I did at my day job.
My first gig was only 145 hours, but the gig income was equal to almost three months of my regular salary! And yes, not only does this say something good about the gig, but it also says something sad about my salary back then.
Had you asked me then what my hourly rate of pay was at my job, I’d quickly calculate it for you since I’ve always been great with numbers.
Only one problem… my answer would have been dead wrong. Here’s why.
Myth: Your Hourly Rate Is Your Income Divided by Your Work Hours
Albert Einstein reportedly said that one should simplify every problem as far as possible, but no further!
Calculating your hourly rate by dividing your annual salary by your annual hours at work is a great example of simplifying beyond what’s possible, to the point that the answer is simply wrong.
Using such an over-simplified calculation, you miss the time you spend getting ready for work; getting to work; getting back home from work; unwinding from work; and responding to work-related calls, emails, and text messages outside of work hours.
You also don’t account for expenses that you only have because of your work (e.g., office-wear, dry cleaning, commuting costs, etc.).
Finally, you don’t account for the fact that the government takes a bite out of your earnings.
Getting the Calculation Right
To account for all the things your mythological earning power misses, let’s take a hypothetical worker, call her Jane, who makes $60,000/year and gets 15 paid days off per year. Jane is married to Jack, who makes the same income as Jane. The couple lives in Maryland, and have two young kids who go to before- and after-school programs during the school year and to day-camp in the summer, so Jane and Jack can keep working.
If Jane followed the above myth, she’d think her hourly rate is $60,000 divided by 1960 annual hours worked (40 hours a week, 49 weeks a year).
That would give her a figure of $30.61/hour.
Not too shabby, right?
More than quadruple the federal minimum wage, and nearly triple the higher 2020 Maryland state minimum wage of $11/hour.
The only problem is that like my calculation back in the day, Jane’s answer would be dead wrong.
Here’s a more accurate accounting.
First, let’s go from gross income to actual net income:
Now that we know that Jane makes only $38,500 net of work-related costs and taxes, let’s see how much time she spends earning this net income, weekly and then per year.
Dividing Jane’s $38,500 net income by the 2940 annual hours she spends to bring in that money, her real hourly rate is just $13.10!
Jane makes less than 43% as much per hour as she thought!
The above calculation doesn’t account for the employer’s half of your Social Security and Medicare taxes, or fringe benefits that you may receive.
For example, your employer may contribute toward your health insurance premiums, match your contributions to retirement plans (e.g., 401k or SIMPLE IRAs). To find your own net income, add to your pay the value to you of those fringe benefits.
Next, if your employer offers more (or less) paid time off, your annual hours would be lower (or higher, respectively).
The Bottom Line
The way most people think of their hourly rate is closer to what employers pay per hour of work. However, that’s not the number you should care about. To learn the real value of your income to you, you need to account for all your unreimbursed work-related expenses, taxes, and work-related time spent outside of hours at the office.
What percentage of your nominal hourly rate is purely mythological?
About the author:
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.