What is labor burden and how do you calculate it?

Understanding labor burden helps you manage business costs, budget accurately, and ensure profitability. If you only consider direct labor costs, like base wages or salaries, you might underestimate your real expenses by a long shot. Labor burden accounts for everything beyond those base wages, like payroll taxes, employee benefits, and other indirect costs.

For HR managers and small business owners, knowing the full scope of your labor costs can help you price projects correctly, set realistic budgets, and make informed hiring decisions. Miscalculating your labor burden can lead to thin margins, surprise expenses, or even losses.

So, what exactly is labor burden, and how can you get a handle on it? In this article, we cover it all, from understanding what labor burden is to calculating it accurately and keeping labor costs in check.

What is labor burden?

Labor burden refers to the additional costs you incur when employing people beyond direct labor wages or salaries. These extra costs, often called indirect costs, cover everything it takes to support an employee within your business. Think of labor burden as the full picture of your labor costs. It's not just an employee's base salary or hourly pay, but every other cost attached to having that person on your payroll.

Understanding your labor burden is important because it helps you calculate your true cost per employee and avoid underpricing projects or overextending your budget.

Your burden rate is the percentage that represents these indirect expenses relative to direct labor. This metric can give you a clear snapshot of what it truly costs to keep your workforce running.

What costs does the labor burden cover? 

Below, you can see some of the key components of labor burden:

1. Payroll taxes

Payroll taxes are mandatory contributions that employers deduct, withhold, file, and remit on their employees' behalf. Employers must also make contributions to certain taxes for their employees. These include federal, state, and local taxes like Social Security, Medicare, and unemployment taxes.

For example, in the US, employers pay 6.2% of an employee’s wage for Social Security and 1.45% for Medicare. These taxes often make up a significant part of your overall labor costs.

2. Employee benefits 

Employee benefits include perks like health insurance, retirement plans, and other forms of compensation beyond wages. These benefits are essential for attracting and retaining talent, but as the second-highest employer cost after salaries and wages, they also significantly add to your labor burden.

For instance, offering a 401(k) with an employer match or providing comprehensive health insurance can greatly increase your total indirect costs. These benefits can enhance employee satisfaction, but come at an expense you need to plan for.

3. Paid time off

Paid time off (PTO) refers to any time you pay an employee who's not actively working. This can include vacations, sick leave, parental leave, personal leave, family leave, and any other type of paid leave. While PTO contributes to employee well-being by giving workers time to rest and recharge without worrying about financial strain, it means paying an employee's wage even when they’re off the clock, so it contributes to your labor burden.

For example, if an employee earns $20 per hour and takes a week of PTO, that's $800 in overhead costs that need to be factored into your labor burden.

4. Training and professional development 

Training and professional development costs cover everything from onboarding new employees to upskilling your current team. Investing in training is necessary to improve productivity and maintain quality work standards.

For example, if you spend $1,000 per employee annually on training courses and certifications, that’s an added cost contributing to your total labor burden. These expenses ensure your workforce stays competitive but need to be budgeted accurately—and added to your labor burden.

The importance of labor burden

Labor burden can make or break your bottom line. Here’s how accurate calculations and an in-depth understanding of labor burden can directly benefit your business:

1. Improved cost management 

Knowing your burden rate ensures you’re taking into account indirect labor costs, like payroll taxes, health insurance, and training, when estimating project costs. For example, if your labor burden adds 25% to base wages, a $50,000 project with $40,000 in wages actually costs $50,000 in total labor. Accurate calculations prevent you from underpricing your services and protect your profit margins.

2. Realistic budgets and forecasts

Accurately calculating your burden rate helps you create budgets that reflect the true cost of your workforce. For example, a $50,000 salary actually costs $65,000 when you add costs like training, equipment, and workers' compensation insurance. Including these costs in your forecasts ensures you avoid budget shortfalls and can confidently plan for growth and expenses over the next six months to a year.

3. Better employee compensation strategies

A full understanding of labor burden helps you design compensation packages that are competitive and sustainable. Knowing how indirect costs like benefits, taxes, and insurance affect your burden rate allows you to balance salaries and perks effectively. For example, if your labor burden adds 30% to base wages, a $60,000 salary actually costs $78,000. With this insight, you can explore strategies like partnering with a professional employer organization (PEO) to gain access to high-quality benefits at lower costs. This way, you can attract and retain top talent while protecting your profit margins.

4. Identification of opportunities to cut costs

By breaking down labor burden components, you can identify effective ways to reduce expenses. For example, if your workers’ compensation insurance costs are high, partnering with a PEO can give you access to pay-as-you-go plans and lower group rates. If benefits-related costs are a significant portion of your labor burden, using benefits administration software can streamline enrollment, reduce errors, and help you find more affordable options. 

5. Smarter hiring decisions

Accurately calculating labor burden helps you determine if hiring is financially viable. For example, if adding an employee costs $70,000 in direct costs and $20,000 in overhead, you might consider outsourcing non-core functions to avoid over-hiring. Using headcount planning software can also help align your team with recruitment goals, compensation bands, and workforce needs. This can help you hire strategically, keep employment costs in check and maintain a balanced, cost-effective workforce.

How to calculate labor burden: 4 steps

While using a labor burden calculator can make this process quicker and easier, it’s still a good idea to understand how to calculate burden rate manually. Knowing the steps can help you spot errors, verify results, and better control your labor costs. Here’s a step-by-step guide to help you calculate your labor burden and burden rate:

Step 1. Determine gross pay

Calculate the employee's gross pay. This includes their direct labor costs, such as wages or salaries before taxes and deductions. For example:

An employee earns $25 per hour and works 40 hours per week.

Gross pay: $25 × 40 = $1,000 per week.

Step 2. Add employee benefits and taxes

Next, add up the costs of employee benefits and payroll taxes. This includes (but isn’t limited to):

• Payroll taxes (e.g., Social Security, Medicare)
• Health insurance
• Retirement contributions
• Paid time off

Be sure to account for all benefits you offer when adding up your employees’ indirect costs.

For example, if these indirect costs total $300 per week:

• Payroll taxes: $100
• Health insurance: $150
• Retirement: $50

Total benefits and taxes: $300

Step 3. Include overhead costs

Factor in any overhead costs related to that employee. These can include:

• Training and development costs
• Workers' compensation insurance
• Equipment and supplies

Let’s say these costs total $200 per week:

• Training: $50
• Workers' compensation: $100
• Supplies: $50

Total overhead costs: $200

Step 4. Divide total labor burden by total wages

Now, add up the gross pay, benefits and taxes, and overhead costs to get the total labor burden. Then, divide the labor burden by the gross pay to get the burden rate:

Burden rate = (gross pay/total labor burden​) × 100%

For example:

• Gross pay: $1,000
• Benefits and taxes: $300
• Overhead costs: $200

Total labor burden: $1,000 + $300 + $200 = $1,500

Burden rate: ($1,500 ÷ $1,000) × 100% = 150%

This means your labor burden adds 50% on top of your employee's base pay. If their hourly rate is $25, your actual cost is $37.50 per hour ($25 × 1.5).

How often should you recalculate labor burden rate?

Labor burden isn’t static. It changes as your business, workforce, and costs evolve. As such, you should recalculate your burden rate on a regular basis, though the right frequency will vary depending on your industry and business needs. Frequent recalculations help you stay on top of fluctuating indirect costs, ensuring your pricing and budgets stay accurate. For example:

• Every six months: This is a good standard for fast-changing industries or businesses with regular workforce changes.
• Annually: At a minimum, review your burden rate once a year to ensure you account for all new costs.
• After major changes: Recalculate when you experience events like:
• A significant number of new hires
• Changes to your compensation or benefits structure
• New regulations affecting payroll taxes or workers' compensation rates

Why recalculation matters

• Cost changes: Factors like increases to health insurance premiums, adjustments to payroll taxes, or new workers’ compensation rates can impact your labor burden significantly. For example, if your health insurance costs rise by 10%, your overall labor burden increases too.
• Workforce growth: Hiring new employees or reducing your workforce can change your labor burden. More employees may mean higher training costs or more benefits to manage.
• Project profitability: If your labor burden is out of date, you risk underestimating project costs. Recalculating ensures you’re factoring in accurate expenses, helping you set competitive prices and protect profit margins.

3 tips for managing and reducing labor burden

Effectively managing your labor burden helps control costs and boost profitability. Here are three practical tips to help you reduce labor burden without compromising quality or employee satisfaction:

1. Streamlining employee benefits packages

Employee benefits are essential, but they can be costly if you don’t manage them efficiently. Regularly review your benefits package to identify perks that employees don’t use and consider eliminating or replacing them with more relevant options. 

Offering flexible benefits plans that let employees choose the perks they value most, such as additional paid time off, commuter benefits, or wellness programs, can reduce unnecessary expenses while maintaining satisfaction. 

2. Outsourcing non-core functions

Outsourcing non-core tasks like IT support, customer service, or bookkeeping can significantly reduce your direct labor costs and burden rate. When you consider the full labor burden of an in-house employee, including indirect costs like benefits, payroll taxes, and training, outsourcing to a service provider for a fixed fee can often be more cost-effective.

For example, if your labor burden adds 30% to an IT employee’s salary, outsourcing IT support may lower costs while maintaining efficiency. Just be sure to weigh the pros and cons: outsourcing can save money and streamline operations, but it may reduce your control over service quality. Evaluating your labor burden helps you decide when outsourcing aligns with your business goals and budget.

3. Reviewing and optimizing worker insurance coverage

Workers' compensation and other insurance policies can significantly increase your labor burden. Regularly reviewing these policies helps ensure you’re not overpaying for coverage. Start by evaluating your current plans and identifying areas where you can reduce costs without sacrificing protection.

For example, partnering with a PEO can give you access to group plans with predictable renewal rates that are often lower than what you can secure on your own. Additionally, improving workplace safety can reduce incidents and lower workers' compensation premiums. Comparing insurance providers annually also helps you find the best coverage at the most competitive rates, keeping your labor burden under control.

Automate compensation and benefits management to reduce labor burden

Managing labor burden effectively is key to maintaining profitability and operational efficiency. Rippling Benefits lets you consolidate all your benefits into one system, automating enrollment, deductions, and administration, which helps you manage indirect costs with ease. By streamlining these processes, you can reduce the administrative overhead associated with compensation management and avoid costly errors.

Additionally, Rippling Headcount Planning can help you align your workforce with your business goals by providing insights into your labor costs. You can forecast headcount needs, ensure compensation bands are realistic, and identify where labor burden may be impacting growth. With Rippling, you get a platform that syncs HR, IT, and Finance into one unified system, making it easier to track labor burden and keep costs in check as your business scales.

Labor burden FAQs

How can technology help manage labor burden?

Technology can make managing labor burden far more efficient by automating calculations, reducing errors, and simplifying compliance. For example, using advanced payroll software can automatically calculate payroll taxes, benefits contributions, and overhead costs. Automated compliance monitoring can help you meet federal, state, and local regulations, which reduces the risk of costly mistakes. Additionally, headcount planning software can help you forecast labor needs accurately, ensuring you budget for all associated costs. 

By automating these processes, technology can reduce administrative effort, improve accuracy, and help you stay on top of labor burden without manually recalculating figures each time your workforce changes.

What are the risks of not properly managing labor burden?

Failing to manage labor burden accurately can lead to significant financial and operational risks. If you underestimate labor costs, you may end up pricing projects too low, eroding profit margins or even incurring losses. For example, if your burden rate is 30%, but you only account for 15%, you'll miss out on covering essential expenses like payroll taxes, insurance, and benefits.

Additionally, overlooking indirect costs, such as workers' compensation, training, and equipment, can result in incomplete calculations and budget shortfalls. Inaccurate calculations can also cause compliance violations, leading to penalties and legal issues. Properly managing labor burden contributes significantly to financial stability and operational efficiency.

Can labor burden vary between employees?

Yes, labor burden can vary significantly between employees because of differences in roles, compensation packages, and benefits. For instance, a salaried employee with full health insurance, a 401(k) match, and extensive training will have a higher labor burden than a part-time worker with minimal benefits. Factors like job location can also influence labor costs due to varying state payroll taxes and workers’ compensation rates.

Moreover, roles that require specialized equipment or certifications add to the labor burden. Understanding these variations helps you calculate accurate labor costs and set appropriate rates for different types of employees.

How can labor burden affect business growth?

Labor burden can significantly influence business growth by impacting profitability, budgeting accuracy, and resource allocation. If you don’t accurately calculate your burden rate, you may underestimate your total labor costs. For instance, focusing only on direct costs like an employee’s wage while ignoring indirect costs such as payroll taxes, benefits, and insurance can lead to pricing projects too low. This can reduce your profit margins and limit your ability to reinvest in growth initiatives.

High labor burden can also affect hiring decisions. If your labor burden is high, adding new employees might strain your budget, slowing down expansion. Conversely, effectively managing and reducing labor burden by streamlining processes or optimizing benefits can help you keep labor costs under control, allowing you to scale more efficiently. Understanding your burden rate ensures you make informed decisions, avoid financial pitfalls, and create a sustainable path for business growth.

What are some examples of labor burden?

Labor burden examples include any costs beyond an employee's base wage. These include payroll taxes, such as Social Security, Medicare, and state unemployment insurance. Benefits like health insurance, retirement contributions, and paid time off are significant components of labor burden. Other examples include workers’ compensation insurance, training and professional development costs, and the cost of providing equipment like laptops or uniforms.

How does labor burden apply to contractors?

Labor burden typically applies to employees, but it can also affect your costs when working with contractors. While contractors don’t incur the same indirect costs as employees, like payroll taxes, benefits, and workers' compensation, they often have higher hourly rates because they cover these expenses themselves. This means the direct costs of hiring a contractor may be higher than an employee's wage when you calculate the overall expense.

Understanding these factors helps you decide when to use contractors versus hiring employees. By comparing the burden rate of employees to the total cost of contractors, you can make strategic decisions that align with your budget and business needs.

This blog is based on information available to Rippling as of December 23, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.