Running a business can involve various hidden costs, especially when you start to hire workers. Business owners and HR professionals must understand their burden rate to avoid unpleasant surprises and ensure they have the budget to support their workforce.
In this article, we'll go over the details of burden rates and why they're an important consideration for any organization.
Takeaways from this blog post:
- Calculating the burden rate helps employers understand the total labor cost of hiring a worker, beyond their direct compensation.
- Understanding the burden rate can help businesses make informed budgeting decisions about pricing, labor, and additional employee benefits.
- Offering cost-effective health benefits, such as a health reimbursement arrangement (HRA), can help businesses reduce their burden rate while still providing valuable employee perks.
A burden rate is the total indirect costs associated with employing a worker, expressed as a percentage of the worker's direct labor cost.
A company's burden rate helps employers compare indirect employment costs to direct costs. Other terms for burden rate include manufacturing burden costs, indirect production costs, labor burden rate, labor burden costs, and other similar terms.
The additional expenses1 that impact the burden rate can include the following:
By calculating burden costs, businesses can more accurately determine the true cost of each employee and allocate resources accordingly.
Overhead costs cover everything it takes to keep a business running, such as electricity, rent, office supplies, marketing costs, and administrative expenses. Labor burden includes the additional costs of employing your team.
To calculate the burden rate, you first need to determine each employee’s total direct and indirect labor costs, which may vary depending on factors such as the employee's base salary, benefits package, and other expenses. Once you have calculated these indirect costs, you can divide them by the employee's direct labor cost (their base salary and wages) to determine the burden rate as a percentage.
For example, if an employee's regular salary is $50,000 per year and their total indirect expenses amount to $15,000, the burden rate would be calculated as follows:
$15,000 (indirect employee costs) / $50,000 (direct labor cost) = 0.30 or 30%
This means that for every dollar spent on direct labor costs, there's an additional 30 cents in indirect employee costs.
Based on information from the U.S. Small Business Administration2, the total cost of an employee is typically around 1.25 to 1.4 times their salary. For example, employing someone with a salary of $35,000 could actually cost $43,750 to $49,000.
By accurately calculating the burden rate, businesses can make more informed decisions about pricing their products or services, budgeting for labor costs, and determining the profitability of certain projects or contracts. It also helps businesses gain insight into their cost structure and pinpoint opportunities for cost reduction or optimization.
If your burden rate shows that you're spending more money than you'd like to be, you may think cutting back on employee benefits is the cost-saving solution to your problem. But this won't go well in the long run.
Doing away with competitive benefits can hurt employee recruitment and retention. According to our 2024 Employee Benefits Survey, 81% of employees said an employer’s benefits package is an important factor in whether or not they accept a job.
Health benefits are also the most desired employee benefit, with 92% of employees rating them as important. Due to the high cost of traditional group health plans, offering a health benefit is often difficult for many employers. This is where a health reimbursement arrangement (HRA) comes in handy.
HRAs are cost-effective alternatives to group health plans. They're IRS-approved, employer-funded health benefits. With an HRA, employers can reimburse their employees tax-free for qualifying healthcare expenses and health insurance premiums. This allows them to reimburse employees for their individual health insurance coverage rather than purchasing a group policy for them.
Here are some of the advantages of HRAs:
Here are two HRAs that work in place of a traditional group health plan:
Running a business costs money. The burden rate is a critical metric for businesses to track and manage their total costs effectively. By calculating and monitoring the burden rate for each employee, businesses can gain valuable insights into their true costs of labor and make more informed financial decisions.
This article is for informational purposes only. If you have additional questions about your situation, you should consult a professional legal or tax advisor.