Predictability and certainty can go a long way in managing your money. What about those of us who live on a variable or unpredictable income stream? (I am speaking to you entrepreneurs and salespeople.)
I remember when my income was largely unpredictable. I had to learn what worked and what didn’t after a lot of trial and error. If you find yourself in the same situation, fear not. I’m here to share some of the winning strategies you can follow when relying heavily on unpredictable income:
Step 1: Make your spending more predictable.
Start by using software or an application like mint or YNAB to track your spending. You can also use a good old pen and paper or an Excel spreadsheet. Whatever works for you is the right choice. Then create a basic spending plan and divide it by:
1. Essential expenses: fixed (mortgage / rent, gym membership, Netflix), variable (utilities, groceries, etc.) or irregular (summer camp, medical expenses)
2. Savings: employee reserves, emergency savings, retirement savings
3. Desires: like traveling and eating out
Step 2: Set up separate accounts to cover the essentials (basic expenses).
1. From step 1, add up your essential expenses which are fixed and variable for the year and divide them by 12. Then create a separate bank account to pay them and label it “essential”. The goal is to know the monthly number you will need to finance these expenses from your income or the salary reserves you have built up.
2) Take the total of all irregular, but essential, expenses that you plan for the year and divide that number by 12. Make a second account for these and label it “irregular”. These will be financed by your income or salary reserves.
3) Set up your “salary reserves” account, which will contain all your income / savings which will be used to finance your expenses.
For example, in my case, I prioritized 1 month of my rent, which was around $ 1,400 per month at the time, for emergency savings and to hit my 401 (k) match. . (I didn’t want to leave free money on the table.) Next, I focused on putting all of my income into my salary reserve account and set funding for my average monthly essentials ( including a gym membership, which was not negotiable for me) automatically. There isn’t just one way to do it. The key is to create an average expense requirement for the essentials in order to create predictability by having a monthly count to hit, to have those expenses funded from the salary reserve account (much like a regular paycheck), and save the rest!
Step 3: Create spending plans that match your income stream and focus on saving.
The key to making this work is to focus on building your savings first. Then you can get yourself a more predictable income stream that will allow you to focus more on your goals and the things you really want. Here’s how to get there based on your income growth:
1) Slow flow of income? Use the Lean Spending Plan:
When times are tough and business slow, you need to have a lean spending plan. This means that your needs (essential expenses) and your savings come first. Needs are extras that can wait for better paydays. During this phase, the key is to have enough in your payroll reserve account to cover the essentials until your income becomes more stable or flush. Try to automate your savings with a trusted number that you know you can save until your income increases.
2) Regular to a stream of income? Use the basic spending plan:
When times are good, take the opportunity to increase your savings and start building your salary reserve account. The goal is to save money first and live within your core budget (meager budget with some non-negotiable desires) until you’ve saved up to a year of spending on reserves. Again, make sure that all of your income goes into your salary reserve account and set your basic expenses automatically so that everything else goes towards building your reserve. Saving up to a year will take time, but once you’re here you’ll feel more confident to move to a standardized spending plan and be able to invest additional cash to fund your various goals (retirement earlier, funding education, buying property, etc.).
3) Sufficient liquidity / salary reserves? Use the standardized spending plan:
Once you have established the salary reserves you need (reach that 1 year!), You can start funding your expense accounts directly from your salary reserve account on a more systematic basis (like a paycheck. regular). You should also be able to start budgeting more for needs and focusing additional cash to accelerate other financial goals. Just be sure to plan ahead each year for any one-time expenses you might have (i.e. new baby birth, education fees, medical bills, etc.) . and allowing you to make the most targeted progress on your financial goals.
Step 4: Have levers to pull when extra cash is needed:
1) Manage and monitor income tax deductions throughout the year to get the most out of your paycheck and not owe money.
2) Consider leveraging your HSA to help pay for current medical bills or reimburse you for past medical bills. (Just make sure you keep those receipts!)
3) Take advantage of an FSA for dependents. If you have children who still need skilled child care (daycare, after-school care, nanny, etc.), you can use pre-tax dollars to fund expenses up to $ 5,000. If you’re in the 24% tax bracket, that’s $ 1,200 savings per year or $ 100 per month!
4) Leverage your savings or investments after assessing the tax implications, trade-offs and financial repercussions. It is better to use the savings you earn 1-2% on rather than borrowing money at a high interest rate. (Any debt with an interest rate of 4-7% or more may be considered high interest depending on your personal financial situation and what type of investor / saver you are.)
5) Consider funding a Roth IRA. It can have a dual purpose of safeguarding emergency savings and saving for retirement. In an emergency, you can withdraw the amount of your contributions at any time without paying taxes or penalties. If you don’t need the cash, you’ve funded a supplemental retirement vehicle that can help you manage your income and taxes in retirement. Just make sure you don’t dip into income or interest unless you’ve opened the Roth for 5 years and are over 59 and a half, otherwise you’ll have to pay taxes and a potential penalty of 10 %.
6) Borrow from a third party (loans between individuals, banks, credit unions, etc.). Cost is the interest set by a bank or any institution you borrow from. The risk is to get into a lot of debt and not have the income necessary to repay it. When exploring options like these, make sure you factor in the risks and have a reliable enough plan to pay it off, like a bridging loan.
7) Ask your friends and family for help. Depending on your family, this can be easy, accessible, and very inexpensive. There is no impact on credit, but there could be social consequences depending on your family dynamics. If you wanted to present the idea as an investment option, you could work with a local bank and issue a promissory note with an interest rate and repayment terms. It’s like a loan between friends and family, but I hope it comes on much better terms.
8) Get a 401 (k) loan. Keep in mind that borrowing on your 401 (k) can delay retirement by not investing that money and potentially increasing it for your retirement. Plus, you’ll pay the after-tax interest and pay interest tax again when you retire it (double taxation). The advantage is that no credit check is required and you pay yourself interest. Just don’t default on your loan or take an actual distribution or you will owe IRS taxes and a 10% penalty if you are under 59 and a half.
9) Treat yourself! If you can fit it into your schedule, you can easily create additional income to help cover your expenses and even increase your reserves. Things like Uber, Lyft, or Instacart can be a great way to use your free time to make money. If you are looking for more project-based work, sites like Fiverr can be a great solution. Check out this post our team produced side pushes for more inspiration!
10) Use the equity in the home. If you have sufficient equity and good credit, you can get a home equity loan or line of credit at a relatively low interest rate. Just be aware of variable rates which can increase your borrowing costs and / or payments. As a bridging loan, this can be a viable solution. The risk is that the additional debt and declining equity in your home can create a problem if your property goes down in value and / or you become inundated with debt.
Step 5: Enjoy the peace of mind
As you can see, managing your variable income and expenses takes time and effort. By focusing on predictability, building your savings first, and having a set of options available in the event of a cash shortage, you can create peace of mind and win at the variable income game! Before making a decision, be sure to think carefully about the pros, cons, and tradeoffs of each option. If you’re having trouble getting started or sticking to your plan, be sure to contact a trusted financial professional for help every step of the way.