Contracting vs. Permanent Employment

[Updated: 11/9 to include a note about Pensions]

I was recently asked for my opinion on whether I thought that contracting was a good idea.  My immediate, reactive thought was to answer with an emphatic “Yes!”, but I then started to consider the question more carefully.  After all, just because contracting works for me that’s not necessarily the case for everyone.  Some of my colleagues have left the world of contracting behind them to return to permanent employment and have no regrets whatsoever; i.e. it’s working for them.

Instead of expressing an opinion on whether it’s a good idea to contract, I decided instead that this post would be about what I’ve learned from personal experience, as well as from contracting colleagues and friends, about contracting.  Considering which parts give me pleasure and which parts I don’t enjoy at all.

Please your own comments or questions here, this post isn’t exhaustive at all and my experience is just that: my (limited) experience.

So, on that note, let’s start with the elephant in the room.

The Money

Most of us associate the act of becoming an IT contractor with getting more money.  A few minutes spent searching on any job site will show a stark difference between the going permanent and contract rates.  According to IT Jobs Watch[1] (this week), the average .NET developer contract rate is £350 per day.

As most permanent, salaried members of staff get paid an annual rate and not a daily rate, we need to do some maths to compare.  For 52 weeks in a year and off for 8 bank holidays[2], and for the sake of easy maths, 22 days on holiday; we have a total of 5 * (52 – ((22 + 8) / 5) = 230 working days a year.

Multiple that by our daily rate and the total potential income will be a healthy £80,500.  Compare this with IT Jobs Watch, which states that the average .NET developer salary today is £40k[3].

If you then consider more lucrative roles, such as Enterprise Architect, rates than can vary from £500 to £800 a day, then that takes the total to a rather smile-inducing £115,000 to £184,000.

However, it’s not quite that simple.  I underlined “total potential income” to emphasise that I did not say “your actual total income”.  Every contractor I’ve met has their own company of some kind that is then contracted by a third party.  This money is paid to and is therefore income for the company, not you.  Here are some of the things that you will or may need to pay out for as a company, before cash comes to you:

1. Tax.  Of course, contractors have to pay tax  There are ways to be more “tax-efficient” as a contractor, but ultimately you’ll still pay, if you want to stay on the right side of HMRC’s rules!  This leads on to point two…
2. Accountants.  Unless you’re doing all your own book-keeping you’ll want an accountant to do it for you.  Accountants are generally very smart people who deal with the (extreme) complexities of UK tax law and regulations to keep everything legal and help you avoid unpleasant surprise bills or fines.  I would be totally lost without my accountant and delegate as much as I possibly can to them, freeing me up to worry about being an architect.  Personally, I’ve found some aspects of this extremely stressful and has led to a few sleepless nights of worry; especially at the beginning when you’re being bombarded by new terms and new rules.
3. Pension.  No matter how young you (think you) are, pensions are important.  As an independent contractor you’ll now need to sort this for yourself.  Your accountant may be able to recommend an Independent Financial Advisor who’ll be able to take you through the options and allow you to make a decision on what pension works for you, also Money Saving Expert has a good guide, or just search the Internet for “pension advice” (although make sure any sites you use are reputable, there’s quite a few scammers out there).  A lot of people find the concept of having their own pension intimidating, but I’ve found that once I got my head around some basics (such as: “it’s basically a savings account with special tax rules”), it’s actually very simple indeed.  For me, it’s a case of: 1) Set up a standing order or DD to money in every month; 2) Once a year, review where you are and where you’ll be at your target retirement age and adjust payments accordingly.  Pretty easy really!
4. Training.  Most companies will not train contractors – after all, you’re there to fix a short-term problem (ideally) so should know what you’re doing on day 1.  Therefore, if you want to develop your skills or even keep them current, it’ll be on your time and at your expense.  When working out the impact of training, don’t forget to include the fact that not only will course fees apply, you also won’t be invoicing that week.
5. Sick pay.  Unless you decide to purchase separate insurance, then any time you’re not working, the company is not receiving any income.  Consider, what if you were diagnosed with a serious illness or had an accident and were unable to work for 1month, 3 months, 6 months, a year or even never again?  Most permanent employees receive a level of “sick pay allowance” which you just won’t have.
6. “Perks”, such as health Insurance, sickness insurance, staff discounts and so on.  Many companies offer perks to employees, such as discounted insurance.  As a supplier and not an employee you’ll not be getting those discounts.
7. Miscellany.  You’ll may want or need things such as professional liability/indemnity insurance, books, a laptop, a mobile phone, software.  All of these things are up to you.

So, after all that, will you better off as a contractor?  That’s up to you to work out for yourself.  It’s always worth considering that a contractor who charges £350 a day, but doesn’t have a contract, is a lot worse off than a permanent employee on £30k (see Job Security below).

Personally, I enjoy the fact that I’m free to choose what to spend my company’s money on, rather it being the product of a corporate policy.  The pension scheme, perks, and training my company provides me suit me perfectly, of course, and when my circumstances change, I can also change these aspects to maintain that.

The Problem of Money Addiction

There’s another, more subtle, reason why I believe it’s a mistake to think or refer to the money earned as “your income”.  When I wake up in the morning, feeling a bit peaky, I used to immediately do a quick mental check: “If I stay in bed today, I won’t earn any money. Is a day off in bed worth £££?”

I used to do this and found it a very dangerous line of reasoning that led me to some very self-destructive habits.  I found I almost always answered the question “no, it’s not worth that much, I’ll drag myself in to work”.  I’d push through the day and get the job done, drugging and dragging myself through meetings and emails until the blessed home time came around.

This led to two things:

1. Work/Life balance seriously deteriorating.  I’d get home and be so tired that I had to go straight to bed.  At weekends I had no energy so needed to nap for a couple of hours during the day.

2. Increased intensity of symptoms.  If I tried to ignore feeling ill, even if it was just a cold, for too long then eventually my body would decide it had been abused enough and just crash.  I’d feel so awful I’d have to stay in bed for 2-3 days at a time to recover, just sleeping and drinking water and generally moaning and being a pain in the backside to my wife.

I realised eventually that it was better to take one or two days off to recover, instead of pushing myself to illness.  Of course, financially it makes sense as well, better to take one day off sick than three! 

I now try to member the line, often attributed to the 14th Dalai Lama[4]: “He sacrifices his health in order to make money.  Then he sacrifices his money to recuperate his health.”

Job Security

Job security is perceived to be the big risk, or downside, of contracting.  This used to terrify me, and still does worry me from time to time.  As a contractor you can be on as little as zero notice (“Sorry Andy, we don’t need you any more”, or even worse, “We would love you to stay, but all contractors are cancelled as of today.  Sorry… and bye!”); or all the up to several weeks.  However, what I’ve learned from talking to fellow contractors is that this generally turns out to be a lottery.  I’ve met contractors who’ve been with one client for 6 years, yet others who find themselves bouncing around different clients month to month, or even week to week.  I’ve also met contractors who have had notice periods ignored by employers with a “Yeah, we know that’s not what’s in the contract, but we don’t think you’ll do anything about it.”

One great piece of advice I’ve had from pretty much all other contractors is to “build a buffer”.  This means trying to save enough money so that you can go for a reasonable amount of time without work.  That way sudden termination won’t suddenly mean you can’t pay the mortgage.  But what’s reasonable?  My idea of reasonable may not be yours, after all!

This is what I did:

1. Worked out the lifestyle I could “enjoy” and “tolerate” and how much a month that will cost. 
2. Consider: “If I was let go tomorrow, how quickly could I find employment?”.  There’s no correct answer to this, but by keeping an eye the various job sites (just search for them, there’s no shortage of supply!) to see if there’s opportunities that I could sensibly apply for, I was able to reason: “Surely I could get one of those in a pinch?”
3. Multiply the outputs of 1 and 2 and this is how much money you want to keep in your bank account (or the company bank account, taking in to account the other costs above) at all times.

If you can save enough to reach the point where you can honestly say to yourself: “I could go, say, 3 months without work if I really had to” then hopefully this will give you peace of mind.

Also, one thing I’ve noticed is that just because you’re permanent employee, doesn’t mean you’re safe from suddenly finding yourself without a job.  Redundancies are not as uncommon as we’d all like them to be, and I’ve worked in more than one company where the turnover of permanent employees was greater than that of contractors for some periods of time.

Are You Actually Any Good?

Following on neatly from job security, there’s always the question of “Are you actually any good at what you’re trying to get a contract to do?”  Be honest with yourself: there’s a big difference between “It’s a stretch but I could do this” and “I have no idea what I’m doing”.  If you keep getting in to contracts where you cannot fulfil the client’s needs then you’ll find yourself being quickly dropped.

Once your CV is littered with short engagements, your potential clients may regard you warily and start asking awkward questions, such as “So, why did you only stay at this client for 2 weeks?” or even worse, making assumptions: “We’re looking for someone to last the duration of this project of 6 months and your history shows you generally terminate after 3 months” and not contacting you at all.

Having said that, I remember, as a young, permanent employee, having a very strong belief that all contractors were super-human geniuses, capable of extraordinarily feats of development or architecture and thus fully worth every penny of their seemingly huge day rates.

Oh, how I can now laugh looking back!  I think it’s arguable that the bar is higher for contractors, but probably not as high as you’re thinking.  Your mileage, of course, may vary.

Extra Overheads

Running your own company takes time and effort, over and above what you do for your clients.  Even with a good accountant you’ll still need to arrange the affairs of the company, read and understand contracts, file expenses and so on.  Of course, you can employ or contract someone else to do it – at a cost.  By some delegating I’ve found that when everything is running smoothly, I can manage by dedicating a 2-3 of hours a week to “running” Locima.  But it’s taken a while to get the processes streamlined to that point.

Some of the regular activities are:

1. Logging all invoices.
2. Logging all payments in to the company account and out again.  I.e. making sure that invoices are being paid in full.
3. Logging all expenses and scanning all receipts.
4. Logging all bills and their payments and scanning all related paperwork.
5. Filing all physical documents.
6. Checking backups (I found Scott Hanselman’s Rule of Three invaluable for this [5]).

Annoyingly, these overheads can suddenly go up: What if a customer refuses to pay, or decides to under pay?  Do you have the means (and will) to take them to court if necessary?  Will it turn out to be good money after bad?  Also what if HMRC decide to audit the company? That’ll take up potentially a lot of your time, potentially.

External events, outside of your control, can sometimes demand large amounts of your time.  Whilst some clients may be sympathetic, others may not – after all, that’s not their problem.

Perks

Running my own (very simple) company has given me a great opportunity to learn how the world of business works in more detail.  The employer/employee relationship is different from the customer/supplier relationship.  Without having to work through all of the items I’ve raised in this post I would be largely ignorant of it as my work typically involves different disciplines.

Of course, there are some things which I absolutely love about contracting:

Annual Reviews

This one makes me smile each time I think about it.  I remember many painful annual review processes from being a permanent employee that I no longer have to participate in:

1. Hours spent preparing an annual (or if really unlucky, semi-annual) statement of achievements; having to set irrelevant (or soon-to-be-irrelevant) goals and having a “personal development plan” (often ignored by both employer and employee).
2. Frustrating and irrelevant tick-lists of competences you needed to demonstrate to get a bonus or promotion.
3. Being told “Sorry, we’ve got a quota/smaller pot of money this year” having fulfilled the criteria of the first two.

My reviews typically consist of, nearing the end of the contract, me asking two questions of the client.  The first is “Would you like to renew me for another period?”  If the answer is no, then the review is done and I can plan future work.  If the answer is yes then there may be a small amount of negotiation of a new rate; but this is generally resolved in a short email exchange.  Either way, I’ve found reviews for contractors are quick, straightforward and get straight to the key points for both me and the client.

I think that this is because decision on contractor renewals are frequently made more locally, for example by the project manager of the project I’m working on.  Firing or “releasing” a permanent employee can be a difficult and costly process, involving HR and several layers of management approval.  But for a contractor it’s extremely easy: “Andy costs X, he delivers Y.  Is this working for this project?”  Of course, different companies work in different ways so your mileage, as they say, may vary.

In summary: my clients don’t (and shouldn’t) care about my career development or my personal support needs.  That’s my responsibility.

Flexibility

Flexibility is another aspect of contracting that I enjoy, greatly.  I am, effectively, my own boss.  Once the terms and conditions of a contract with a third party of fulfilled, the rest of my time is mine to do with as I choose.  This allows me to have multiple clients (subject to competition and similar clauses) or work on my own projects.  In fact, if you have a long-term client then consider the impact that could have on your tax situation (see an accountant), such as from IR35.

Many permanent members of staff, at least in the UK IT market, including myself, have signed contracts in the past that mean that my employer owns all my output, even if done in my time on my equipment with absolutely no connection with my day job.

Conclusion

For me, right now, I’m really enjoying running Locima and the contractor lifestyle: the clients I work for, the projects I do for myself, the personal development I do for myself and the freedom to know that I have far more control (or at least perceived control) over my own destiny.

Of course, in the months and years to come when the job market changes, my lifestyle requirements change or just my luck changes, I may decide that it’s no longer the contractor life for me.  At that point it’ll be time to go back to port and the safer(?) shores of permanent employment.

You, on the other hand, may have a totally different experience!

References

[1] .NET Development Contracts, IT Jobs Watch as of 2/9/14 – http://www.itjobswatch.co.uk/contracts/uk/.net%20developer.do

[2] England only: New Year’s Day, Good Friday, Easter Monday, Early May Day Bank Holiday, Spring Bank Holiday, Summer Bank Holiday, Christmas Day, Boxing Day – http://publicholidays.co.uk/

[3] Wikiquote page on the 14th Dalai Lama – http://en.wikiquote.org/wiki/Talk:Tenzin_Gyatso,_14th_Dalai_Lama

[4] .NET Developer Jobs, IT Jobs Watch as of 2/9/14 – http://www.itjobswatch.co.uk/jobs/uk/.net%20developer.do

[5] The Computer Backup Rule of Three, by Scott Hanselman – http://www.hanselman.com/blog/TheComputerBackupRuleOfThree.aspx