Why Most Freelancers Undercharge
The most common pricing mistake in service businesses is simple: owners pick an hourly rate that sounds reasonable, without working backward from what they actually need to earn. They compare themselves to employed workers making $40/hr or $50/hr and assume that charging the same rate is fair. It is not. Employees get health insurance, paid vacation, retirement contributions, payroll taxes covered, equipment, and office space—all paid by their employer. A freelancer or business owner must fund all of that out of their hourly rate.
According to the Bureau of Labor Statistics Occupational Employment Statistics, the total cost of employer-provided benefits adds 30–40% on top of wages for the average private industry worker. That means an employee earning $50/hr actually costs their employer $65–$70/hr. If you charge $50/hr as a freelancer, you are effectively accepting compensation well below what an employer would pay for the same work.
The 30 Billable Hours Reality
When you work a 40-hour week as a business owner, you do not bill 40 hours. You spend time on invoicing, bookkeeping, marketing, sales calls, email, administrative tasks, and continuing education. The industry standard estimate is that solo service providers bill about 60–75% of their working hours. That is 24 to 30 billable hours per week out of a 40-hour work week.
This is the single largest blind spot in hourly rate calculations. If you divide your target income by 2,080 hours (40 hours times 52 weeks), you are assuming 100% utilization—something that is physically impossible when you are also running the business. A more realistic denominator is 1,200 to 1,500 billable hours per year. That alone can double the rate you need to charge.
Accounting for Taxes
Self-employment taxes add another layer that many new business owners forget. In the United States, self-employed individuals pay both the employee and employer portions of Social Security and Medicare taxes—a combined 15.3% on net earnings up to the Social Security wage base. Add federal and state income taxes on top of that, and 25–40% of your gross revenue can go to taxes depending on your income level and state.
The Small Business Administration recommends that self-employed individuals set aside 25–30% of gross income for taxes as a starting baseline. Your profit margin in this calculator should account for this tax burden. If you want to take home $100,000 after taxes, your target income should be $130,000–$140,000 or more depending on your tax situation.
The Case for Raising Your Rates
Business owners consistently overestimate the risk of losing clients when they raise rates, and underestimate the damage of underpricing. Here is why raising rates is almost always the right move:
- Fewer clients, same revenue: A 25% rate increase means you can lose up to 20% of your clients and still earn the same revenue—but with significantly less work and stress.
- Better clients: Price-sensitive clients tend to be the most demanding and least loyal. Raising rates naturally filters for clients who value quality over cost.
- Sustainability: Underpriced work leads to burnout. If you need to work 60-hour weeks to earn a living wage, your business model is broken, not your work ethic.
- Compounding effect: A rate increase compounds across every hour you bill for the rest of the year. A $10/hr increase across 1,440 billable hours is $14,400 in additional annual revenue.
When to Use Project-Based Pricing Instead
Hourly rates are transparent and easy to understand, but they have a fundamental flaw: they penalize efficiency. The faster you get at your work, the less you earn. This creates a perverse incentive to work slowly, and it caps your income at the number of hours you can physically work.
Consider switching to project-based or value-based pricing when:
- You can deliver results significantly faster than a client expects, because experience and systems have made you efficient.
- The value of the outcome far exceeds the cost of the time involved. A consultant who spends 10 hours creating a strategy that saves a client $500,000 should not charge $1,500.
- You want to scale beyond trading hours for dollars. Project pricing lets you delegate components of the work without the client seeing (or caring about) the hourly math.
Even if you price by the project, this hourly rate calculator is still essential. Your required hourly rate is the floor beneath any project price. If a project estimate divided by your expected hours comes in below this number, the project is not worth taking.
Building Your Rate Over Time
Very few service providers can command premium rates from day one. The path typically looks like this:
- Year one: Charge enough to cover costs and build a portfolio. Track every hour meticulously so you understand your true utilization rate and cost structure.
- Year two: Raise rates 15–25% for new clients. Grandfather existing clients temporarily, then bring them up at the next contract renewal.
- Year three and beyond: Specialize, niche down, and continue raising rates annually. The SCORE mentoring network offers free guidance on pricing strategy and business planning that can help you make these transitions.
The key insight: your rate should increase every year. If it is the same as it was two years ago, you are losing money to inflation and leaving expertise value on the table.
Sources
- Bureau of Labor Statistics — Occupational Employment and Wage Statistics — Wage and compensation data across industries
- U.S. Small Business Administration — Calculate Your Startup Costs — Cost structure and tax guidance for small businesses
- SCORE — Templates & Resources — Free financial planning tools and mentoring for small business owners