Build Your Own Benefits Package

Dungaree Dan says:
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Build Your Own Benefits Package

General Considerations

Most people automatically think of health insurance when the subject of employee benefits is raised. It is true that health insurance is one of the more important benefits that employees are likely to receive. But, as we learned in the discussion on Annual Salary vs Hourly Pay, the typical corporate employee receives many more "benefits" than health insurance alone. One tends to overlook the considerable "personnel overhead" associated with the care and upkeep of a permanent employee.

Corporate accountants typically figure on a labor load of 30% to 40%. But, the contract employee generally pays for these expenses out of pocket, at full price, and with "after-tax" income, so the equivalent labor load may approach 55% or more in replacement costs. Moreover, corporate employees receive up to ten weeks of paid time off every year, including paid vacations, national holidays, sick days, personal/mental health days, and time set aside for training, conventions, retreats and special events. Contract employees are not similarly compensated.

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Insurance For Contract Employees

Employer-provided Insurance
Employers provide the following types of insurance for their employees:

  1. Workers Compensation
  2. Unemployment
  3. Social Security/Medicare
  4. Disability
  5. Health
  6. Dental
  7. Vision
  8. Life
  9. Long Term Care Insurance

Workers Compensation Insurance
Workers compensation provides replacement income and pays medical expenses when an employee is injured on the job. Employers must provide coverage if they have a minimum number of employees, ranging from one to five, depending on individual state's requirements. How much an employer pays for coverage depends on the job classification of the covered employees and the employer's history of prior claims. Costs to the employer can be high, ranging up to 12% or more of total salaries paid in high risk industries with numerous prior claims. Coverage for clerical and white collar employees is naturally much lower. Employment agencies that supply leased workers (temps and contract employees) to client companies are rated according to the claims histories of their clients.

Payments for workers compensation coverage are part of the employer's cost of doing business, and are not withheld from employees' paychecks.

Unemployment Insurance
The Federal Unemployment Tax Act (FUTA) mandates that all states provide employees with unemployment compensation, also referred to as unemployment insurance. Employers are required to pay both federal and state unemployment taxes. Except for the states of Alaska, New Jersey, Pennsylvania and Rhode Island, where employees make a small contribution out of their paychecks to the state unemployment insurance fund, employees do not pay federal or state unemployment taxes.

Federal and state unemployment taxes (except for the four states noted above) are part of the employer's overhead, and are not withheld from employees' paychecks.

Social Security/Medicare
Social Security and Medicare taxes are established by the Federal Income Contributions Act (FICA). FICA taxes fund federal entitlements such as Social Security retirement payments, welfare programs, and basic medical insurance for seniors and the disabled. In 1997 the tax rate was 15.3 percent of the first $65,400 in wages. Wages above $65,400 were taxed at the rate of 2.9 percent for Medicare only. The employer pays half the FICA taxes, and half is withheld from the employee's paycheck.

Disability Insurance
Five states, (California, Hawaii, New Jersey, New York and Rhode Island) and Puerto Rico have disability insurance programs that provide employees with coverage for injuries or illnesses that are not related to work. Remember, workers compensation insurance covers injuries that are related to your work. Disability insurance payments are withheld from the employee's paycheck. Employers make additional payments in Hawaii, New Jersey and New York.

Health Insurance
Employers may offer the following levels of coverage for health insurance:

  • No coverage -- Employee must find own coverage.
  • Group Plan -- Employee pays 100% with after-tax income.
  • Group Plan -- Employee pays 100% with pre-tax income.
  • Group Plan -- Employee pays some, employer pays some.
  • Group Plan -- Employer pays 100%.

In addition to providing insurance for the employee, the employer may also pay a portion or all of the premiums for the employee's spouse and legal dependents. Many larger companies offer cafeteria plans. In a cafeteria plan the employer gives the employee an allowance with which to purchase insurance from a wide selection of insurance plans. What the employee doesn't spend on insurance is usually kept as additional income. Most employees, however, have little choice but to enroll in the one health plan provided by their employer.

When insurance is provided by the employer, its coverage automatically ceases when the employee quits or is laid off. This is not a serious problem when employees work their whole lives for one company. But in today's employment environment it is not unusual for employees to change employers every two or three years. And contract employees may change agencies several times a year as they move from assignment to assignment.

In a move to increase employee loyalty, and in response to competition from other agencies, many agencies now offer group health insurance to their employees. In most programs contract employees pay 100% of the premium with pre-tax income, thereby receiving access to group rates at a discount equal to their tax bracket. As attractive as this option appears, it is probably not advisable that contract employees obtain health insurance through their employment agency. The reasons are described in the following paragraphs.

Employees may extend their health insurance after termination through COBRA, the Consolidated Omnibus Budget Reconciliation Act. COBRA mandates that employers with 20 or more employees must offer continuation coverage with a premium no greater that 102% of the actual premium cost. Coverage under COBRA can last for up to 18 months, at which time the former employee may convert to an individual policy, usually at a significantly higher cost. There are two advantages to COBRA. First, it provides coverage until the worker gets another job, and can qualify for insurance under the new employer. Second, COBRA provides for coverage in the event a covered individual has acquired a preexisting condition that would otherwise result in denial of coverage.

In 1996 Congress passed a law that makes employee health insurance portable from one employer to another. In other words, group health insurance coverage can no longer be denied to a worker solely because of their health status, claims history or medical condition. Coverage for preexisting conditions, however, may be excluded for a period of 12 months. As appealing as this law is for permanent employees, it provides only a stopgap solution for contract employees who may change agencies as frequently as every several months. Can you imagine going from agency to agency, first applying for coverage under COBRA, then waiting out the qualification period with your new agency until you can sign up with their program, only to go back under COBRA almost as soon as you have adjusted to your new coverage? Even with the new law, purchasing insurance through your contract employment agency is certainly possible, but hardly practical for most contract employees.

Types of Insurance Coverage
Group policies are preferable to individual policies, and large groups are preferable to small groups. Group plans pool the insurance policies of many people, thereby spreading the risk that any one serious illness or chronic condition will adversely affect individual premiums. Group plans are not permitted to single out individuals for higher premiums. If premiums are raised, they must by law be raised equally for everyone in the group. When groups are too small, the risk is not spread as far. Therefore the addition of one new employee with an expensive health problem may result in significantly higher premiums for everyone in the group. To avoid this problem, select a group plan with several thousand policy holders.

Groups may consist of the employees of a single company, or a group of companies. But, insurance groups needn't be defined by what company you work for. A group can be the membership of a trade group or professional association. A group may even consist of isolated individuals whose only commonality is that they joined an association whose primary purpose is to sell insurance to its membership.

Insurance plans fall naturally into three general categories:

  • Traditional Plans
  • Health Maintenance Organizations (HMOs)
  • Preferred Provider Organizations (PPOs)

Traditional Plans are increasingly rare, being supplanted by HMOs and PPOs. Traditional plans allow policy holders to go to any health care provider they want. Because traditional plans exercise little control over the cost of health care, they tend to be more expensive, and require that the insured share the expense by paying a deductible and co-payments. Deductibles discourage numerous small claims, each having a relatively high administrative overhead. Co-payments discourage unnecessary, expensive procedures.

Health Maintenance Organizations offer pre-paid plans that require their members to use doctors and hospitals belonging to the HMO. HMOs have no deductible, and they typically charge a nominal fixed co-payment for office visits and prescriptions. The HMO assigns a primary physician who acts as your general practitioner, and you are not allowed to seek the care of a specialist without a specific referral from your primary physician. Ironically, physicians in an HMO may be overruled by office workers who are simply following written guidelines, and who have no medical training at all. The operative word here is pre-paid. Doctors and hospitals that belong to an HMO have already been paid all they will ever get before you even seek treatment. The most effective way for an HMO to increase its profit margin is to discourage, delay or deny the provision of health care. Indeed, some HMOs actually pay their physicians a bonus based on how few referrals they make for additional tests and treatments.

Because HMOs are relatively inexpensive (You get what you pay for!), they are favored by employers who provide paid health benefits to their employees. Unfortunately, this practice often locks employees into what many are coming to believe is a marginal delivery of health care. Contrary to appearance, HMOs are NOT insurance companies, so they are not regulated by the State Department of Insurance the way insurance companies are. For example, in California HMOs fall under the aegis of the Department of Corporations.

Another disadvantage of HMOs is their local or regional coverage. If you accept a temporary assignment outside your HMO's service area, you may find yourself disenfranchised from easy access to health care.

Preferred Provider Organizations offer the advantages of both Traditional Plans and HMOs with few of the disadvantages of either. PPOs establish a network of doctors and hospitals that agree to provide health care services at rates set by the PPO. You may be required to pay a deductible and co-payments, and if you seek health care outside the network you will be required to pay a higher portion of the bill.

Although most PPOs are regional, some have networks that span the country. And, if you do accept an assignment outside your PPO's area of coverage, you are not entirely disenfranchised. You can still select a doctor or hospital of your choice, and pay a higher deductible and co-payments.

The doctors and hospitals that belong to a PPO are paid after the delivery of health care. Thus there is little or no incentive to discourage, delay or deny the provision of health care. Indeed, within reasonable limits, the more health care a physician prescribes, the more the physician is paid.

Americans can now take advantage of a new law that allows the establishment of medical savings accounts. MSAs are similar in concept to an IRA. You establish your MSA at a bank or other financial institution. Interest earned on money in a medical savings account is not taxed, and money withdrawn to pay for deductibles and other medical expenses is tax free. Properly used, a medical savings account can significantly lower your medical expenses.

As a savvy contract employee you will want to obtain health insurance having the following characteristics:

  • Insurance coverage is independent of your employment status.
  • Offered through a reputable professional organization with many members.
  • Policy is for a group plan comprised of several thousand policy holders.
  • Policy is for a Preferred Provider Organization.
  • Coverage is available anywhere you expect to live and work.

Contrary to popular belief, affordable, quality health insurance coverage is available for contract employees, just as it is for self-employed business people. In fact, as a contract employee you have access to a much wider selection of policy options than most permanent employees who feel obligated to take what their employer has to offer.

Vision Insurance
Vision insurance is often bundled with your health insurance. A typical plan provides free annual eye exams and free glasses every two years. Contact lenses are available at a discount.

Dental Insurance
Approach the search for dental insurance as you would any other form of health insurance. Select a group plan offered through an established professional association with many members. If your mouth is in good shape, select a plan with low premiums and high deductibles and co-payments. If your teeth need a lot of work, select a plan with high premiums and low deductibles and co-payments. When the expensive work is completed in a year or two, you can switch back to a plan with lower premiums. Most plans provide free annual check-ups, cleanings and x-rays. These free visits give the dentist an opportunity to inspect your teeth, and recommend needed repairs (How else will they get your business?). Expensive procedures, such as crowns and bridge work, usually require a 12-month waiting period before they are covered. Routine fillings are covered as soon as the policy goes into effect. Cosmetic options, such as porcelain crowns instead of metal crowns, usually have higher co-payments.

Some membership programs establish agreements with dentists that set limits on the amount they will charge for specified procedures. If you require very little oral care, this may be the way to go. These programs are not a form of insurance, and you must pay the full amount specified by the program. Nevertheless, membership fees are lower than insurance premiums, and if your teeth are healthy you may come out ahead over the cost of insurance.

Life Insurance
The face value of employer-paid life insurance is usually just large enough to pay for your funeral, and little more than that. If you do purchase life insurance for yourself and your family, seriously consider decreasing term insurance. Term insurance is the least expensive. Decreasing term insurance has a fixed premium, and the face value decreases as you grow older. Coverage ceases when the term expires. Hopefully, by then you will have a healthy retirement nest egg that could support either you or your spouse in the event one of you dies.

Long Term Care Insurance
If you want to protect your family's assets, it may be far more practical to invest in long term care insurance. These policies pay for visiting nurses to care for you in your own home. They also pay for your room and board should you require assisted living care in a residential care facility, or 24-hour nursing care in a nursing home.

Medicare provides only limited coverage for rehabilitation following a stay in the hospital. With limited exceptions, Medicare does not cover long term nursing care for the mentally and physically frail. If you cannot afford to pay for long term care yourself, Medicaid will make payments for you. Medicaid (not to be confused with Medicare) is a form of social security. Medicaid makes minimum payments to participating nursing homes and other long term care providers.

Nursing homes typically charge $3000 to $5000 per month. Medicaid pays for only the most basic home health and nursing home care, and you must exhaust all but $2000 of your life's savings before you become eligible for Medicaid benefits. Without careful prior planning (Who plans to become permanently incapacitated?) your chronic infirmity can force your spouse into a life of poverty. If your children cannot stand to see you in a "Medicaid nursing home", and they decide to place you in a "private pay facility", their assets as well may be seriously depleted.

Approximately 80 percent of nursing home residents are women, and the average stay for permanent residents is about five years. At $60,000 per year for decent care, you and your family can expect to pay over a quarter of a million dollars in long term care during your final years. Of course, this is all before your beneficiaries collect a single penny of any life insurance you may have taken out.

Medicaid has a particularly perverse restriction on third party augmentation of Medicaid payments. This means you are either restricted to a facility that accepts absurdly low Medicaid payments as total payment for your care, with correspondingly marginal delivery of care, or your family must pay 100% out of pocket for a higher level of care, even if you qualify for Medicaid. Medicaid does not allow your family to supplement Medicaid payments in order for you to afford better care.

A few enlightened larger corporations are beginning to offer long term care insurance to their permanent employees. As a contract employee you will need to purchase long term care insurance on your own. The premiums are really quite low if you sign up while you are still relatively young. Long term care insurance is one of the wisest investments you can make for your senior years.

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Other Benefits And Perks

Large corporations provide their permanent employees with a great many fringe benefits and perks in addition to insurance. For contract employees, who must provide their own benefits and perks out of pocket, the aggregate replacement value can be enormous. If you fail to take into account the full dollar value of all the benefits and perks you received as an employee, you are likely to grossly underprice the value of your services, and cheat yourself out of thousands of dollars in annual compensation. The following discussion is based on the list of additional sources of compensation given in the section called Annual Salary vs Hourly Pay.

Professional Expenses
As a matter of course, companies provide all the software their employees need to properly perform their jobs. And, corporate site licenses usually contain language that allows permanent employees of the company to install the same software on their home computers at no additional charge so they can do company work at home after hours and while telecommuting. But, site licenses generally do not extend to leased employees, so as a contract employee, you may have to purchase your own software if you work from home.

Companies also routinely subscribe to trade magazines and professional journals, as well as pay their employees' dues to job related professional organizations. As a contract employee, you pay for these out of pocket.

Company Perks
It is a well known fact that contractors never receive annual bonuses, performance bonuses, profit sharing, stock options, merit increases, or any other corporate incentives usually afforded to permanent employees. As a contract employee, you will need to factor in these lost sources of compensation when computing your minimum acceptable hourly pay rate.

If you gave up a company car to become a contract employee, you must factor in the real value of that car, including gas, oil, tires, scheduled maintenance, insurance and incidental expenses.

You may have been provided a laptop computer, pager, cell phone, data line to your home, and other tools of the trade, including rental, usage and maintenance fees. The aggregate value of these services can be $1000 to $2000 per year, or more. As a contract employee, you will pay for these items out of pocket.

Permanent employees often have access to their company's in-house fitness center. Some receive corporate memberships at a local gym. Contract employees are denied such benefits. In fact, access to the corporate fitness center by contract employees can be used by the IRS during an audit to establish a pattern of co-employment, with adverse consequences for the client. A contract employee may have to pay a thousand dollars or more each year for equivalent health club benefits.

As a contract employee, only your employer of record can require you to participate in employer paid training programs, and they can't afford it. Moreover, client companies are so gun-shy on the subject of training (Training is the second common law factor on the IRS' infamous list) that they rarely offer it to their contract workers, even though voluntary training is now permitted under new IRS guidelines. Contract employees are expected to build their skill sets on their own time, and at their own cost. Of course, if you are resourceful, you might be able to squeeze in some on-the-job training as did Dungaree Dan.

Larger corporations routinely pay the tuition for work related courses and training classes. They send their employers to seminars, conventions and "team building" retreats, all at company expense. Each day of formal training costs your company at least $500 per person. If you have ever paid your own admission to a fast-track training seminar, you probably paid more than that. If the training is out of town, add at least $200 per day for travel, food and lodging.

Corporate employees typically spend more that two weeks a year in some kind of corporate training at a minimum annual cost of $5000 ($500/day times 10 days). Make sure you budget an equivalent amount when you compute your minimum acceptable hourly pay rate as a contract employee.

Retirement Program
Permanent employees are familiar with company sponsored 401(k) plans. Larger companies usually make a matching payment to the employee's 401(k) retirement account according to a set formula. Additionally, companies may have separate pension plans which kick in after a period of vesting, ranging from two to five years. Contract employees are generally not entitled to benefit from the client's pension plan, because they are not the client's employees. However, recent rulings, most notably involving contractors at Microsoft, have established a precedent in which contractors were declared de facto employees or co-employees of the client company for retirement purposes, and thereby were entitled to stock options and pension benefits following termination of their contracts.

Despite legal precedents to the contrary, contract employees do not receive generous retirement plans from their clients, and certainly not from their own employers, the contract employment agencies. More and more, agencies are offering their contract employees access to 401(k) plans which the employees can roll over from agency to agency as they accept various assignments. But the principle advantage would seem to accrue to the agency in the form of employee loyalty and retention. Agencies do not make matching payments to their employees 401(k) plans. That benefit is only given to permanent employees by the client companies themselves.

The employer's contribution to a typical mid-level employee's retirement plan can equal 10 to 20% of the permanent employee's annual salary. Contract employees, on the other hand, must build their own retirement plans through savings, prudent investments, their personal IRA, and preferably a 401(k) plan that is independent of any one agency. A good source for your 401(k) plan would be a participating professional association, perhaps the same one you used as a source for your group health insurance.

As a contract employee, it is imperative that you add 10 to 20% to your minimum hourly pay rate, and then religiously set that amount aside each payday in a separate account for your retirement.

Severance Pay
Severance is an allowance, usually based on length of service, that is payable to an employee upon termination of employment. Contract employment agencies never pay severance. As a contract employee, you are entitled to collect unemployment benefits between assignments just like any other employee. There is an waiting period of at least one week before you are eligible to collect. Unemployment benefits are not severance pay.

It is a simple matter to create your own severance package. Simply allow for reasonable periods of unemployment when you compute your minimum hourly pay rate. Then set aside enough money in a short term emergency fund to tide yourself over between assignments. If you don't budget for periods of unemployment, you stand the risk of running out of money, and having to settle for less than you are worth on your next assignment.

Pre-Tax vs. After-Tax Dollars
Employees don't pay income taxes on benefits and perks. Consequently, employees receive a double discount on every benefit and perk their employer gives them. First, companies can negotiate much better rates than individuals. Secondly, when benefits and perks are purchased with pre-tax dollars, the employee receives an additional discount equal to the size of their tax bracket.

As a contract employee you must buy your benefits on the open market with after-tax dollars, thereby incurring a significant hit to your pocketbook. Professional associations provide access to discounted health benefits, and some contract employment agencies offer pre-tax, employee-paid health benefits. But, no contract employment agency will give you anything close to the benefits and perks provided by larger companies to their permanent employees.

Paid Days Off
It is a fact of life for contract employees that they only get paid for the hours they actually work. Permanent employees, on the other hand, may receive up to ten weeks, or more, paid days off every year. Here's how it breaks out:

  • Vacation -- Mid-level permanent employees of larger corporations typically receive at least three weeks paid vacation each year. Long-term permanent employees may accummulate as much as six weeks paid vacation.
  • National Holidays -- Permanent, salaried employees receive from nine to eleven paid national holidays. That's an additional two weeks spread throughout the year.
  • Sick Days, Personal, and Mental Health Days -- Most companies also provide a total of at least two weeks off with pay for illness, stress reduction, family emergencies, and personal business.
  • Training, Conventions, Etc. -- Permanent employees spend at least two weeks a year in company provided training, all-expense-paid trips to conventions, team building retreats, and other non-work activities. Permanent employees may argue that these activities qualify as work, but the fact remains that contract employees are never paid for personal training, trips to conventions, retreats, or any other similar activity.

Some contract employment agencies advertise paid days off after a qualification period, but they come nowhere close to the number and type of paid days off provided by their client companies. As a contract employee, you must factor in all the days you will not be paid when computing your minimum acceptable hourly pay rate.

Factoring It All In
Now let's look at how you can factor in the replacement value of your own benefits and perks, and also give yourself paid days off. You do this when you compute your minimum acceptable hourly pay rate as a contract employee.

First, let's revisit the equation for computing your minimum acceptable pay rate from the section called Annual Salary vs Hourly Pay:

(Annual Salary  +  Additional Compensation)  /
(Actual "Billable" Hours)  =  Hourly Pay Rate

Now, let's assume that an equivalent permanent employee is paid $60,000 to do what you do. If you give yourself no benefits, and you take no days off, the equation will look like this:

($60,000)  /  (2080 Hours)  =  $28.85/hour

This illustrates a common mistake make by contract employees when they try to figure out what their hourly pay rate should be. They forget to factor in a typical employee's benefits, perks, and paid days off.

Now let's see what happens when we factor in a reasonable benefits package and paid days off. Assume that the total annualized replacement value of your benefits and perks, including health benefits, professional expenses, bonuses, tools of the trade, training, retirement plan, etc., is $35,000. Assume, also, that you give yourself a reasonable nine weeks off during the year for vacation, national holidays, sick leave, and training. In other words, you only plan to bill 43 weeks, or 1720 hours in a given year.

The corrected equation now looks like this:

($60,000  +  $35,000)  /  (1720 Hours)  =  $55.23/hour

If you do not allow for reasonable benefits, perks, and paid days off, you will seriously undervalue your worth as a contract employee, possibly by as much as a factor of two!

You may be surprised to learn from this exercise that your agency wants to pay you significantly less than your minimum acceptable hourly pay rate. In other words, if you are to earn at least as much as a permanent employee doing the same job, with the same benefits and perks, and taking the same number of days off, your agency will have to pay you much more than they are offering. The solution, of course, is to practice the methods discussed in the sections called Landing Your Next Assignment and Your Mission as a Contract Employee.

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Last Update: 09/17/97