Does the idea of figuring out how much payroll will cost you give you hives? Adding up each person’s salary, paid time off (PTO), FICA taxes, retirement contributions, healthcare benefits, and any other compensation you can’t quite think of at the moment is a dreadful task indeed.
But do you really have to add up every penny that you’ll pay toward an employee’s total compensation?
The answer might surprise you.
Do I Have to Figure Out Every Single Payroll Cost?
Most people use a payroll service so that they don’t have to think about state and local taxes, FUTA liabilities, and so forth. Many of the costs just come in every pay period like clockwork. A good payroll service helps you track these costs over time.
Still, before you can enter numbers into a payroll software service, you have to know what those numbers are. This means you need to estimate payroll costs for things like budgeting, hiring, and giving raises. Even the best payroll service can’t help you there.
Not only is it tedious and time-consuming to estimate these costs exactly, but things like overtime and health care premiums are also impossible to predict.
The good news is that most owners don’t worry about tracking every last payroll cost when they need to make decisions about hiring, promotions, or reorganizations. They use a simple, time-tested formula that calculates fully loaded payroll costs in seconds.
The 25 Percent Formula for Payroll Costs
This formula isn’t my trick. I learned it from someone who learned it from someone else, and it works so well that I’m passing it on to you.
Here it is. To find the fully-loaded cost of a role, add 25 percent on top of that role’s salary. The formula is:
Salary x 1.25 = Payroll Cost for Role
Let’s put it to work.
Say you own a restaurant and you want to promote your best shift leader to a role as an assistant manager. It’s a new role, so you’re not sure how much it’ll cost you. Your restaurant manager could use the help, though, and you’re about to promote one of your servers to take over that shift leader role.
You’ve taken a look at your restaurant’s budget to determine the salary you can pay your new assistant manager—$65,000 a year.
You want to provide a benefits package, too: dental, vision, healthcare, retirement, life insurance, and 14 days of PTO.
But how much will these benefits cost you? And how much will you need to pay in Social Security and Medicare taxes for this new role? What about Federal Unemployment Tax Act (FUTA) tax and worker’s compensation insurance?
If you try to untangle all of these costs, you’ll waste precious time in your workday.
Instead, apply the 25 percent formula for payroll costs:
$65,000 x 1.25 = $81,250
And there you have it. You’ll need to budget $81,250 to cover the costs of the newly formed assistant manager role at your restaurant. This amount should cover extra payroll costs from health benefits and worker’s comp to PTO and retirement contributions.
Yes, I said should. The formula isn’t perfect 100% of the time, of course. It’ll be a little off for every employee, but typically in a good way. As in, you’ll be over-budget for each role.
This is a good thing. The extra cushion acts as a safety net for the employees who do go over the 25% mark.
And if more employees go over the 25% mark than not, you can adjust the percentage to 30 or 35%.
All in all, the 25 percent formula helps you make decisions when you don’t have time to shut yourself away in your office for hours on end and ignore the world around you. (Which is probably never.)
Combine the 25 percent formula with our payroll budget guide and free payroll budget template and you’ve got the tools you need to successfully manage your payroll. With our template, you can easily adjust salaries and fully loaded payroll costs.
You Still Have to Watch Payroll Costs
The one thing you can’t forget is that even when everything’s coming in under budget, you’ll want to keep a close eye on specific payroll costs.
Variable pay is a big one. Some months tend to cost more in variable pay than others. If you’re a restaurant owner and you stay open during the holidays, you’ll have to pay overtime. You might even decide to pay double or triple overtime for the people who work on Thanksgiving or Christmas Day.
This means you’ll end up footing more in payroll costs that month. Bonuses might play a role in higher holiday costs, too, so make sure you’re ready.
Another thing to keep an eye on is taxes. State and federal taxes can fluctuate from year to year, depending on who’s in charge of the local and federal government.
With FUTA, for example, federal law gives employers a FUTA tax credit of up to 5.4% (instead of 6.0%) if they already pay wages that are liable for state unemployment tax.
Not all states have an unemployment tax. But for those that do, employers can pay just 0.6% of taxable wages per employee. Since FUTA is paid on wages up to $7,000 per employee, you’d pay $42 in FUTA taxes for each employee rather than $420.
However, some states experience FUTA credit reductions if they have taken out unemployment insurance loans from the government and haven’t paid them back. In California, the 2022 FUTA credit was 0.3%, reducing the credit to 5.1%. This means employers had to pay an additional $21 per employee that year for FUTA.
That might sound like a small amount, but if you have a lot of employees, it adds up quickly. Plus, the government will continue to drop the state’s FUTA tax credit by 0.3% until the loan is repaid.
Finally, there’s the cost of payroll itself. From direct deposit fees to payroll software fees, keep an eye on those little costs that add up quickly.
And yes, you absolutely do need to use a payroll service and not a simple spreadsheet.
A payroll service helps you stay compliant with state and local laws. It streamlines the often time-consuming task of doling out compensation to all of your employees. And most importantly, it greatly reduces errors that could cost you big bucks to fix.
Check out our top 5 recommended payroll services to see which one would work best for you.