How to budget for an irregular income
I’ve been a full-time professional blogger for more than a year now. It has been a fantastic experience, a sort of dream come true. But blogging for dollars is not without its drawbacks. As I’ve shared before, I feel socially isolated. I spend most of my time in this office, writing about money.
Also, the income can be irregular. For some bloggers, it is very irregular. One month you might have record earnings — and the next you might experience your own personal financial crisis. Bloggers aren’t the only folks who struggle with the fluctuating incomes, of course. Many self-employed people face the same issue, as do those whose pay is tied to commission.
Creating a budget when your income fluctuates can be a frustrating experience. I am sure that each of us finds our own ways to cope. Today, I want to share the method that I’ve developed.
Projecting Income
Most articles I’ve read on this subject suggest basing your budget on your average monthly income from the past 12 (or six or three) months, but I don’t recommend that unless your income has wild swings — $12,000 one month and $0 the next. As this past year has demonstrated, incomes can and do decline. A prolonged decline wreaks havoc with the “average income” budgeting method.
When I project my cash flow, I base it on my minimum monthly income from the past 12 months. Using my minimum monthly income instead of my average monthly income gives me a safety buffer. And when you have an irregular income, a safety buffer is vital.
Note: If your income is variable, but you know that you will always make at least $X,XXX, then it makes sense to base your budget on $X,XXX. Anything you earn above this amount is gravy.
A Hypothetical Example
For the sake of illustration, I constructed a hypothetical example of the monthly income a freelance designer might have earned in 2008:
The “actual” column shows the designer’s actual income by month. The “average” column shows the average for the entire year. Using the standard advice, this designer would then construct her 2009 budget based on the average monthly income from 2008. Her 2009 budget would be $3,891.67 per month. But what if her income declined in 2009, as has happened to many freelancers? Here is a plausible scenario:
In this instance, the designer’s average monthly income for 2009 was $3,600, or nearly $300 less than she budgeted. And because her first few months were fantastic, she might have been tempted to splurge beyond her budget. That would have been a mistake. If, instead, she had constructed a budget based on her lowest month in 2008, she would have done okay.
Now, obviously I fabricated these numbers out of thin air in order to make a point. But based on recent conversations with a variety of people who earn irregular income (bloggers, designers, contractors, entrepreneurs), many folks are facing this sort of situation in 2009. Their incomes have dropped, and their budgets weren’t ready to cope with this.
Building a Budget
Projecting cash flow is only part of the battle. After finding a basis for my budget, I followed a simple system to manage my money. I recommend using two different bank accounts to make this work:
- The first is your “business” account (without quotes for those of you who actually own businesses), which is where you deposit all of your income. My business account is a high-yield savings account with ING Direct. (You might use FNBO Direct or some other bank. Just choose something with a high interest rate.)
- The second is your personal account, and it is from this that you will pay your ongoing expenses. There is no need to open a new account if you already have one that will work. I just use my existing credit union checking account.
Every month as you earn income, receive it (and leave it) in your business account. This is where you accumulate your cash. Because it’s in a high-yield account, it earns interest as it waits for you to use it.
From this money, pay yourself as if you were an employee. Your monthly salary is whatever you calculated as your monthly budget, your minimum monthly income from the past 12 months. On a set date each month, write yourself a paycheck. Leave the rest of the money in your business account. (Here’s more on the “virtual employer” concept.)
At I’ve Paid for This Twice Already, PT writes that “the key to budgeting with irregular income [is to] make it mimic regular income as much as possible.” I agree.
At the end of each year, three things happen.
- First, you reset your salary. Based on the previous year’s numbers, your income might increase — or it might decrease.
- Next, you use the “extra” money you have been accumulating in your business account to pay taxes. I could write an entire article on budgeting for taxes with an irregular income, but for now let’s just note that it is very important that you remember to account for them, especially if nobody else is withholding them from your paycheck.
- Finally, if you have anything left after paying taxes, you pull this money out of the business account as personal income. It is, in essence, a year-end bonus. You can use it for whatever you see fit: debt reduction, long-term savings, a Mini Cooper.
Reading through this, my system seems complex. It’s not. It is actually very easy. To summarize: I base my budget on my lowest monthly income from the previous year. When money comes in, it sits in a high-yield savings account. Each month, I write myself a paycheck based on my budgeted amount. The rest of the money is saved to pay taxes. If there’s any left over at the end of the year, I get a bonus.
Note: The first year is difficult. You generally don’t have the ability to base your budget on averages or on the lowest income from the last 12 months. (I was able to do this because I’d been earning money before I quit to blog full-time.) Instead, you’ll have to use some other method to project your income. Whatever you do, remember: It is easier to deal with a budget surplus than it is to deal with a budget deficit!
Tips and Tricks
There are few other things that make living with an irregular income go more smoothly. The following tips and tricks build on the core personal finance skills we discuss often here at Get Rich Slowly:
- Establish a foundation of thrift. The number one thing that helped me cope with an irregular income was adopting a lifestyle of thrift. I took steps to slash my spending. I decreased my recurring monthly expenses. I found cheap or free alternatives to the things I used to spend money on (Hulu instead of cable television, the public library instead of the bookstore, etc.).
- Prioritize spending. Many of the budgeting guides I’ve read suggest creating a list of prioritized expenses. Financial guru Dave Ramsey, for example, recommends listing all of your expenses in order of importance. (“Importance, not urgency,” he says.) When you get paid, start at the top of the list and work down. This is an excellent method for those who are struggling to make ends meet.
- Build a buffer of savings. Before I quit my “real” job to become a full-time blogger, I began to set aside a large sum of money as an emergency fund. I figured that if my income dropped below the minimum I needed to get by, I could tap the emergency fund to provide supplemental cash. With luck, I’d be able to ride out any rocky storms. (I’ve been fortunate to not have to do this.) When you have an irregular income, the bigger your emergency savings, the better.
- Tap your business account only as needed. As money accumulates in your business account, you will be tempted to draw from this pool for fun and games. Don’t do it. Remind yourself that this money is for taxes — and for your monthly salary.
- Resist lifestyle inflation — especially during the good months. Lynnae at Being Frugal writes: “One of the biggest downfalls of having a variable income is the tendency to overspend on good months. Believe me, I understand. Your money is stretched to the limits in the lean months, so on a good month, you’re tempted to spend a little bit more on fun stuff. But when the next lean month comes, there’s no extra money left to help ride it out.”
- If possible, live off just one income. If you have an irregular income but you have a partner who makes steady money, explore the possibility of living solely on her income. Use your partner’s money to meet the necessities, and use yours to pay for savings and extras. This isn’t an option for most people; but if you can manage it, it is a great way to budget.
Do you have irregular income? If so, how do you budget for the fluctuations? Can you offer any additional tips? I am especially interested in tips for those who are just getting started with self-employment or variable incomes.
Become A Money Boss And Join 15,000 Others
Subscribe to the GRS Insider (FREE) and we’ll give you a copy of the Money Boss Manifesto (also FREE)
There are 72 comments to "How to budget for an irregular income".
Great article,
I am in the same situation in that I have an irregular income – I plan my budget on a rolling 3 month basis.
Here is an article I wrote which others might find interesting.
http://www.shrewdcookie.com/financial-planning/cashflow-forecasting-planning-income-and-expenditure
My irregular income (as a freelance designer / part-time-retail worker) is highly irregular, but all on the low end. One month I may make $500 (usually the minimum) and other months I may make $2000 (the extreme rare maximum). Usually I average around $600-$800 a month.
I have a very minimal budget that only includes the bare necessities: rent, utilities, gas, food, medication. This budget is around $800. Most months, I can just *barely* make just enough to cover it. On the few months where I make more, I save all the excess. Then, on the few months where I make less, I can dip into the savings to help make ends meet.
I guess I can’t offer any additional tips.. my only strategy is to spend as little as possible, even in the months where income is high, and to save any bit of excess over the bare necessities, because it might be needed for later.
My contract work is also extremely irregular. I can go months at zero (no work), months at 6K and months at $12K (very long days/weeks, traveling), with zero warning as to when the changes occur, and my wife is a SAHM.
I have migrated to this kind of 2 account system (what I call my income account versus my expense account). I can’t really use a minimum number for the “paycheck” b/c of the months at zero, but I defintely don’t spend my average number either. Truthfully, we have figured out what number we are “living comfortably” with (turned out to be $4K/month) and, because this number is significantly less than my average pay, I don’t see a reason to change it.
It is this living off of $4K even the months I make $12K that have turned long periods of no work from stressful emergencies into nice long vacactions.
Mr Chiots and I have an irregular income since we own our own business and we make most of our money 8 months out of the year. We have actually set a salary for ourselves and we transfer that money in each month and we leave the rest to accumulate. At the end of the year (or when our busy season starts and money is coming in again) we transfer excess to savings. This way we’ve been able to built up a personal emergency fund as well as a business emergency fund to cover expenses for 12 months.
Migrating to an irregular income from a regular one is the toughest part. I would recommend having a good emergency fund in place and learning to live on a strict bare bones budget when you first do it. After a couple years you have a good feel for the money flow and it’s much easier at that point.
JD,
I really appreciate the hands on “how-to” approach to this article. As I continue to grow my little side gig, I am on the lookout for ways to improve budgeting and admin tasks.
While I can’t offer any advice here since I’m just starting out, I am very glad you took the time to write something like this for us.
Thanks for this article. I have the all important tax question: My partner just started a part-time job that required her to fill out a 1099. Right now, she will earn a minimum of $360/week and we want to start a budget off of that. Our major concern is come tax time, what will be required of her to pay in taxes. What kind of percentage should we be budgeting per week for the tax bill at the end of the year?
@Lonnie (#6)
There’s no one right way to answer “how much should I save for taxes?” It depends on a lot of variables. I always say that the best solution is to consult a tax professional, such as a CPA.
For myself, I’ve adopted a rule of thumb. I save half of what I earn for taxes. I know that a couple of other pro bloggers do the same. This *way* overestimates how much I’ll actually need, but again, I’d rather have a budget surplus than a deficit.
But what if my income was really close to my budget? Setting aside 50% wouldn’t be reasonable then, and I’d have to use a much more precise number, which might be 37% or 42% depending on my actual income.
Anyhow — the important thing is to get a good estimate as to tax liability and then use this as the basis for your tax savings.
I hadn’t thought about this issue before.
I think the key is to pick some sort of percentage of your expected income to budget on. Using the lowest month is probably ok but what if you had one month that was just horrible? Basing your budget on that amount might not be realistic.
Perhaps a percentage of the average monthly income from the last 12 months is a way to do it. ie 60%.
JD – Thnx for sharing. I have several different sources of irregular income besides my main work income. The passive income of rental property is generally regular, and I always make a spread of X amount which i either uses to pay more down on the rental property principal, or just save in a SEPARATE savings account just for “rental property emergencies.
I also have a vacation property in Lake Tahoe which has seasonal income: Very high in the winter and summer, very low in May, Oct, Nov. and the first half of December. The key is to save any money more than your minimum operating expense during the good months, to pay for your bad months. I tend to also vacation my property during the slow months too, so as to not take away any rental income.
The temptation is HUGE to just splurge on all the extra income during the good months, so it is vital to again create a separate savings account for this different income stream and NOT comingle your funds.
When all debt is paid off, I will then earmark each stream of income towards different expenses. My main rental property for example is large enough to be used for all food & travel expenses. The vacation property rental income will be used for all entertainment purposes and so forth.
Rgds,
RB
Rich By 30 Retire By 40
I am self-employed, and I do basically what you outlined here, with two major differences.
1. I set aside 35% of my earnings into a SEPARATE account for taxes. That way I always have enough for estimated taxes, with that “bonus” you mentioned at the end of the tax year, but the money is out of sight, out of mind.
2. I pay several subcontractors who help me with my business, so I always keep a several-thousand-dollar cushion in my “earnings” account to pay them. I pay them from the “earnings” account rather than my personal-expenses account because those payments are a business expense.
As someone who used to wait tables – this is also great advice for anyone who works in the restaurant biz. Sad to say, but I wish I had read this when I was waiting tables and bartending. At one point I was very good about letting the money sit, but walking away with all that instant take home pay, definitely a lot of money was wasted.
Hopefully some service staff will read this and take it as good advice. With a little tweaking to account for the constant influx of cash this is a wonderful system and most waitstaff would be surprised on just how much money they really make over a period of time.
My husband and I have had an irregular income the entire 14 years we’ve been married. First, it was due to his sales jobs, and after he got out of sales, I was earning an income from blogging. So we have no idea what it’s like to have a regular income to count on.
Your advice is spot on! Thanks for sharing it. It took me years to figure out how to budget for an irregular income, so I hope this post helps someone just starting out.
And thanks for including a link to my article!
I actually do somethign different that what your do..just slightly though..
Instead of looking at my income which fluctuates a lot, I look at my expenses. I use my highest month by regular expenses as the base for my “salary” to myself and then go on from there. I typically spend $1000 on average each month with my highest month being at $1500. So if I made $24K/year, I would keep paying myself $1500/month, and putting any surplus in an emergency fund ( up to 12 months). The rest is then invested in stocks/fixed income.
Thanks for the explanation- feel that too few if any have covered this topic and I’m in a similar situation from short term investments. It really is true- when it’s a feast period the temptation to inflate lifestyle is very hard to resist but then comes back to bite you during periods of less.
Thank you for this post. Budgeting on an irregular income is something I’ve struggled with for years, especially as much my work historically has been project-based and starting up a new project can often take up a lot of financial resources. I’m shifting the kind of work I do now, and this formula will work really well for how my income will be coming in.
Because of “flat rate” we have an irregular income for many years. We use a strict budget I call the “24 plan”. I figure all fixed expenses (yearly insurances, prop. taxes, utilities, house payments, savings and yes Christmas and holiday expeneses, etc.) and divide by 24. (two paydays a month). Then I save on a spread sheet for each category even though its a lump sum in checking. When the expense is due, the money is there. The KEY its not extra just because its sitting there and figure your income as minimal average! If our paydays are bigger than expected, I use my “percents”. I give extra items a percent and thats how much they get of extra income. These are extra fun categories like little extra spending, saving for a whim item, etc. Yes this last year there have been slow times and not quite enough to meet the basic budget. Then the priorites categories are paid and the ones like Christmas money just aren’t for that payday. Using Quicken savings goals I can keep up to date and if I get behind on something I know and its kind of fun (guess money budget people are odd?) to watch you catch up and turn the color to green when you have a bigger than expected payday and can use some of the extra. It is kind of odd but I have to say the 24 plan works for us. Honestly I have had a friend tell me its crazy, but she also pays her car insurance monthly even though she had a huge salary.
Great analysis. I was a full-time freelancer about five years ago and I managed my money very badly. Ultimately, that was part of what lead me to go back to working for an employer. Now that I’m figuring out how to manage my money again, I think the freelance life will work for me when I try it again.
I’ve been a freelance writer for three years now, and my monthly income has fluctuated wildly in that time, from $0 to $11,531. My average monthly income is $2400, but that doesn’t give enough information to budget on, because some of the variation is seasonal: there’s always a drop in February/March/April, for example, because there’s always a drop in work around December/January and my clients take between 30 and 90 days to pay. I have a salaried part-time job that gives me regular income, but that plus my partner’s unemployment insurance (or his income, when he’s working) isn’t quite enough to pay all our bills.
I’ve developed a system similar to the one SJ describes, where I add up all our expenses and figure them in the form of [my steady income] + [my partner’s steady income] + X. Now I know that I need to have at least 2X in freelance income every month. (I put aside half my freelance income for taxes, currently in an ING savings account, though I’m starting to look at 90-day CDs since I empty the tax savings account quarterly to pay my estimated taxes.) 2X is less than $2400, though not by much.
Now that I’ve been at this for a few years, I can set aside a bit of money during good months and use it during lean months, but I’m still recovering from the winter’s credit crunch, when pretty much all of my freelance opportunities vanished and I had to scrounge up a bunch of new clients–despite July being a good month so far, my average monthly income for 2009 is still only about $1850, and if I don’t count July it’s $1300–so in reality it’s been more like dipping into credit in the lean months and paying it off during the good months.
What’s helped the most has been developing a massive spreadsheet for all my freelance-related data, everything from when things are due to my average hourly rate, how quickly clients pay, and yearly graphs of my invoices and income (which look like giant U-shapes at the moment, since the winter was so abysmal) with trendlines and averages. Taking the long view reminds me that I’ve gotten through tough times before and that something good has always turned up, and knowing that I have all my data in one place (and backed up, several times over) gives me a lot of peace of mind. As with so many financial things, the psychology is a big part of it.
@Lonnie, your tax situation depends on how you’ve structured your business; sole-proprietorship (you and your business are the same entity) or corporation. Originally when I was a freelancer (USA) I took work as a W-2 employee of an agency. They paid me as any employer would, taking out taxes etc. Once I incorporated (in the US, you can do a C-Corp, LLP, LLC etc) I used a payroll service that was responsible for making the payroll ( I was those employee ) and submitting all taxes etc. I hired an accountant to do the corporate taxes and filed my own personal taxes separately.
Thank you for this post. As someone beginning to freelance–and preparing to transition out of a job with a steady income–this was a well-timed article for me.
In fact, I can see this general system working even for someone with a steady income (i.e. working for me right now, not just when my steady income goes away!). By having my salary deposited directly into a savings account, I could pay myself a smaller monthly salary out of that account while automatically building my savings! It seems like a good idea for everyone.
BTW, can you full time independs/freelancers share with us what you guys do for health care?
Thnx!
RB
Rich By 30 Retire By 40
I have irregular income because the amount of overtime I work varies. Since I have a minimum monthly income (working 40 hours per week), I budget based on the that, and if I earn more, I just have more money going into savings. I’ve worked a ton of overtime this year and got a nice bonus, which will add about 50% of my base salary to my earnings this year.
My problem is that, even though I have all this “extra” money over and above what I’ve budgeted (which means I’ve built up a huge amount of savings, not even counting my retirement savings), I have a hard time figuring out when it’s ok to spend some of that extra money. I’m afraid that if I get into the habit of spending more than I budgeted, I could get into trouble in the future if I don’t get as much overtime.
@RB (#21)
The most effective way of obtaining health insurance when you don’t have a traditional job is to have a partner who can provide it for you. This isn’t practical in every case, though.
You may want to check out this guest post on how to find affordable health insurance when you’re on your own.
I think it’s a good idea to have two budgets — an expansive budget for good times and a tighter budget for when things are tight. Health insurance would be the same in both budgets. Amounts spend on vacations and new furniture and new cars would not be.
The second budget should be prepared before before the rough times come. The cutbacks should not come as a shock. The should be expected, something incorporated into one’s long-term plan.
Down economic times happen. We should cease being amazed by them.
Rob
What a fantastic article, and timely too (for me)! I love the idea of banking all your income and then issuing yourself a bi-weekly paycheck; that makes so much sense. I’m starting to move into some freelance copyediting work, and while I’m not at the point where I need these suggestions yet, I will certainly be saving this article! Thanks, JD, and also thanks for some of your comments on taxes–I guess I’ll save about 37-40% of what I earn.
Does anyone know of any blogs or webpages that discuss budgeting and saving for freelance taxes? About.com has an article on “Tax Tips for Freelance Professionals,” but it doesn’t get into how to estimate what you’ll owe, and it’s pretty dense.
J.D. – this is an excellent post. Thank you so much for obviously spending quite a bit of time to write it for us.
I make anywhere between $8000 and $30k a month, so budgeting is really difficult for me. Of course, I don’t spend even close to that each month, so I am saving quite a bit – but the difficult part is determining how much to regularly save. This post, however – definitely helps.
Question: do you think it’s smart to pull money from your business accounts and put that into your personal accounts as soon as you have the money (maybe once a month)? This way, just in case you were sued, the money you had previously earned will be protected by your LLC or Corp?
@Pat (#26)
This is a great question. I think it’s largely dependent on your business. And here’s a little secret: I actually have an added layer that I didn’t describe in the article because it would just create unnecessary confusion.
I have an actual business account that receives the money, but then I transfer it to a personal business account at the end of the month. Does that make sense? All of the stuff I described above is done with personal accounts, but there’s an initial actual business layer that things pass through first.
If you’re worried about lawsuits, I think it does make sense to decide which entity offers the best protection. Is your business more likely to be sued? Or are you? Base your holding place on the answer to this question. And consult your lawyer for professional advice! 🙂
@ J.D. (#27)
Thanks for your prompt response. Oh, and I’ve only been reading your RSS feed for awhile, so this is the first time I’ve seen your new blog design. Well done!
Anyways, while first reading this post, I was wondering if you did have a business account that you pass through first or not. I’m actually quite glad to see you’re doing it that way – and it’s the exact same thing I do.
The business layer, or actual business account allows me to more easily write myself a check each month (actually – I print it out from quickbooks – it takes about 2 seconds), and really keep track of what money came into my business, and what comes out for me.
Now, if we could only find a good money market account to put all of that money into. I do miss those days when they were going at 5.25%.
And as far as a lawyer – they are expensive, but don’t let that put you at risk to losing even more money just because you didn’t want to pay for legal advice. Most know what they are doing and know how to do it fast, so it’s definitely best to seek professional help from a lawyer if there are any questions about liability and such.
My contractor husband has an irregular income, and we have constructed our budget/accounts exactly like this. We developed this system on our own because it was easy and seemed to work, but I had no idea it was such a viable way to effectively manage a budget with irregular income. It’s nice to know that we’re doing things relatively “right.” This was fun to read!
One thing we do that I don’t think JD does: We transfer the majority of my husband’s income into our personal checking account, but he keeps some of it in his business account to pay business-related bills (like his work truck and tools). This helps us clearly track those expenses and write them off on our taxes. From what I understand (via our accountant), that wouldn’t be possible if we used our personal account to pay those bills.
Great post!
JD – Thanks for your link and tip on health care. That does sound like the smartest and cheapest way to go, getting on your spouse’s plan. However, I don’t think my spouse would allow me to “retire” alone, and she will want to join me 🙂
Pat – Wow, 8K-30K/month in passive income is inspirational! I have dreams of posting on a yacht in the French Riviera or on a secluded beach somewhere in 10 years.
Thanks for keeping the dream alive!
Best,
RB
Rich By 30 Retire By 40
Great post, one of the things that would scare me into not quitting my normal job (even if I was making enough money) would be the sudden stop in the plan. I’d be horribly afraid of chugging a long great, and then all of a sudden.. “opps!” no cash.
“Reading through this, my system seems complex. It’s not. It’s actually very easy. To summarize: I base my budget on my lowest monthly income from the previous year.”
A good move, I used to do this when I was gauging the value of items I would be selling. Taking into account the lowest sales price offered by competitors, and making sure I could turn a profit at that number if need be. : )
It was pointed out, but this way of thinking is also good for people who work overtime on a regular basis. I have known a number of people who counted on their OT, and then hours were cut back. Or people who live like “National Lampoon’s Christmas Vacation” and spend their annual bonus before it’s in the bank. 2-5% of what I make is a non-base annual bonus, and another 5-10% is OT.
Since OT can play havoc with taxes I Xfer it to a high yield savings account and I don’t do anything with it until after my taxes are filed, then I do my annual distribution to investments, savings, etc.
Some people might find having a chunk at the end of the year inefficient (at least as far as paying expenses) but this money is great for irregular expenses like saving for a car.
Man, I make so much money working from the beach that I don’t know what to do with it all, so thank you J.D. for giving me some good ideas.
Just as an example, I made $1,000,000 last month. If you visit my website, http://www.spammysnakeoilsalesmen.com, you can buy a copy of my book that will tell you how to make as much as I do, because *obviously* everyone can get rich from home, if they just knew what genre of book to sell (which I tell you in my book).
I also have a book on blogging about blogging tips for other bloggers. This is another great sustainable economic model. Just subscribe to my ad-supported blog for my blog tips. Blog.
Oh, and I can get you the hottest new ringtones, only $4.99 each.
Oh by the way, I love reading your site J.D., I don’t just do it as an excuse to advertise my snake oil, I mean, book/blog.
What account do you use to pay your business expenses?
@Lilb (#34)
I always pay my business expenses from my business account and my personal expenses from my personal account. Never the twain shall meet.
Wow, this is a hard topic to wrap up completely, but you’ve done an awesome job.
One strategy I used was to base our budget off of my income from last month. It requires you to get one month ahead, but ensures you never spend more than you made.
Also, more recently, we’ve drastically cut our lifestyle to be able to live off of just 1 income (which happens to be regular). If you are a couple in this situation, you can use ALL of the irregular income for savings, paying down additional debt, traveling, etc…
Obviously, this can’t be for everyone, but it’s worked very well for us!
I am a freelance photographer/web designer/post production retoucher. I am less then a year out of college, so most of my income comes from assisting other photographers right now. For about 10 months now I have been budgeting like the above, taking in checks and payments into my LLC’s account and then paying myself at the end of the month. In the beginning I took a look at what I wanted to be spending on different things, such as rent, bills, gasoline, etc., and built a budget off of that. I came up with $1150, and that is what I “make” per month. In reality I make anywhere from $600-$2400 (worst and best month) wearing the many hats a freelancer must. I have been able to pay myself what I need per month for almost a year now. Some times I don’t use the full $1150, so I take the $137.84 in my spending account and only pay $1012.16 out of the business account.
A few months ago, I swallowed my pride and moved back in with my folks (i’m only 23, so it doesn’t hurt that bad). I was able to keep paying myself $1150/mo, however I socked away what I would spend on rent and anything else I could avoid paying and saved up 3 months salary. Now when I move out in a month I will feel much safer knowing that if I fall a few hundred short of the $1150, I will still get paid $1150. So long as I make up the money over the next few months I should be fine.
The only hiccup is, as with most freelancers, taxes. I am a w-2 employee at one studio, but all the money that my business (most of my clients) makes is untaxed… guess I should get a CPA huh.
This was a helpful post. I hope I can get to a point where I can quit working and blog or be self employed full time.
Shouldn’t 1099ers be paying taxes quarterly, rather than at year-end? I don’t think the IRS’s penalties and interest are that high (though I haven’t investigated them), but why give them any more than you have to?
Actually, having said that, it might be interesting to compare the interest you could earn by paying quarterly taxes late vs. the fees the IRS would charge you. I’ll keep an eye out for that tax article!
Bravo! This should be required reading for anyone who is self-employed or has an irregular income. Managing cash flow, for both large corporations and self-employed individuals, is the key to navigating life’s speed bumps. Especially loved your point about avoiding “lifestyle inflation” – spot on.
Leah (#39) wrote: Shouldn’t 1099ers be paying taxes quarterly, rather than at year-end?
Yes, absolutely. Good point. From my experience, however, quarterly taxes are only a rough approximation. They either estimate too high — or too low. In any event, always keep enough in savings to cover your estimated tax liability.
Ah, JD, you answered my quasi-question that was written as a statement. I see you also pay your business expenses from your business account and reserve the personal account for personal expenses. Whew. Once again, it’s nice to know that we’re doing things “right.”
Again, great post. Looks like it’s helping a lot of people. Especially that guy with the snake oil. Gotta check him out!
Thanks, J.D. This is exactly what I want to read more about in Get Rich Slowly. I am beginning the path of an independent musician and music teacher, and I have been trying to figure out what steps to take to help keep my financial house in order.
Thanks.
I have a regular 9-5 type day job, but since you wrote about the ‘virtual employer’, I’ve been using this method. As someone else noted, this keeps the overtime and bonuses in savings – they don’t get spent without thought, like I used to do. In fact, my monthly savings has doubled because of this (such waste in the past). Thanks for the plan, it’s working great.
Can you explain your whole banking system?
One thing we do is an “Annual Budget” rather than a monthly one (this is good not only for variable income but also for variable expenses). We re-adjust every 6 months. Then I keep a large cushion in my checking account to cover the downs. I also over-save for taxes in a separate account. Once/yr I sweep the overage into a combination of checking, saving, investing. This keeps the month to month bill paying fairly smooth.
The one thing I would change if my income followed an irregular pattern is to budget based on “rolling 12 month minimum”, which would be the lowest month from the immediate last 12 months. The advantage with this method is that if your income is trending downwards due to industry/market conditions, your monthly budget immediately takes this into account. JD’s method would not do this, as the amount is only reset once per year.
Eg. say your minimum monthly for 2008 was $3,000. In Jan 2009 your income is $2,800. A rolling 12 month minimum would be $2,800. But if you only base it on the minimum month from 2008 your budget would stay at $3,000.
Now, is Jan 2009 ($2,800) a special once off low month, or is it the start of a downward trend in your income? If it were a downward trend, you’d definitely want to budget based on rolling 12 month minimum!
To reduce the effect that one bad month has on your budget, you can reduce the period over which you run your rolling minimum. eg. 6 months instead of 12. That way, one bad month only lowers your budget for 6 months not 12.
Hey JD,
One question for you. When would you recommend opening a business bank account? When did you open yours?
Is it imperative that you open one as soon as you make your first freelance dollar, or is it necessary only when you are purely freelance?
I pretty much do what you described here. I base my budget on the minimum monthly income, but also use the average and maximum income as reference points. I pay myself from an account, as if I’m an employee, and leave the rest of the money in the account. If I should ever earn less than my current “minimum monthly income,” I’d make up the difference with the buffer that’s in my business account.
Resisting lifestyle inflation is definitely something I have to pay attention to. I get comfortable in those “fat” months and I want to splurge. In the good months, I give myself a small allowance enough to have a little fun with, but not enough to significantly impact my buffer.
That’s a much more intricate plan than what I wrote you about, but that level of detail can really help sometimes.
I wholeheartedly recommend resisting lifestyle inflation. The extra savings can lead to more opportunities as they present themselves down the road.
My favorite tool as a consultant was working on retainer. I had a couple clients (web design/updates) who wanted ongoing maintenance services. What I did was to offer them a significant discount on my hourly rate, if they would pay for it up front, every month. So, we’d write a contract for 3 or 6 or 12 months of work – five hours per month at $50/hr instead of a la carte at $70/hr. Extra hours over 5 per month were billed at $70/hr; any “unused” hours were forfeited.
I knew I could count on $300/month that way, and they liked knowing they wouldn’t get socked with a big bill one month. (If they needed 7 hours of changes, I’d often do the work the 29th, 30th, 1st, 2nd so they felt they got their money’s worth.)
I also paid myself as an employee once a month, but this at least gave me some firmer numbers to go on.
Emily
This is really a good article with lots of common sense. I also like comment #49 (LaToya). Be aware of the average, live on the minimum, splurge when you are able, pay yourself as an employee, resist lifestyle inflation(easier said than done). Using an allowance sytem (www.theallowancesystem.com) like LaToya does, will keep her focused, disciplined, and yet allow her to have money that she can spend as she pleases without breaking the budget. The allowance system can be used for one person or an entire family.
JD – great suggestions as always. However, I think that Toby’s (#47) suggestion is actually a better method for the reasons he suggested. However, another reason that this method makes more sense is that then you’re not pulling everything out once a year as a bonus. I ran my own business for 9 years and quickly implemented a system like JD suggested. However, at the beginning of second year after I paid myself the year end bonus I had a dip below my minimum for two months with no cushion in the “business” account. I had to make it up out of savings. I then switched to the rolling method and never had that problem again.
It is important that if you build up an excess that you never pull it all out in a bonus! Always keep at least a one month cushion even after you pay your taxes quarterly.
As a teen/young adult, my son has an irregular income. We created a budget for him based on percents (exs: 20% entertainment, 10% Roth, 15% dates, 10% car fund, etc). He only spends what is already available in each category, and his spending had to be adjusted based on his income.
As he got older and has added actual bills, he has adjusted to putting the majority of his beginning of the month income into the categories (like rent) that he has to have available when the bill comes due. Once the responsibilities are taken care of, he can fund his fun categories.
I’m sure an adult would have more trouble with this method due to the larger amt of bills, but it is an excellent way for teens to get started budgeting.
This is a really good article. I’ve been an Independent Contractor for three years now, and I–like many ICs–learned a lot of your tips the hard way. My personal system is very similar to yours, although I have my two bank accounts swapped; my Business/Spending account is a standard checking account while my Personal/Savings account is a high-interest savings account with a credit union. I use this method to capitalize on the interest from the credit union (It continues to grow year-round, whereas the way mentioned above, the high-interest account resets each month when you pay yourself.)
In regards to taxes, filing quarterly is an excellent way to avoid the “oh drat” of having to pay the lump sum of your taxes at the end of the year.
Instead of paying myself at the end of each month, I pay myself every time I file my taxes. Once I pay my quarterly taxes I dump a large portion of my Business account into my Personal/Savings account and quit spending money on “extras” (No Starbucks, no movies, no iTunes etc.) until after I’ve saved enough for my next quarterly payment.
The big thing here is discipline. As an IC , I also figure 50% for taxes right now. The does provide some cushion now but it’s hard to tell what the future holds.
The hardest thing for me to learn was to pay myself first. I also divide income into quarters as I now have enough history to know the ebbs and flows. It doesn’t keep me up nights anymore trying to figure out how to make it through my “ebb” quarter.
This is excellent advice. You could also watch patterns of income throughout the year. For example: February could be your best month, consistently, three years in a row. This is something you can go back and look at to see what to expect.
My husband and I both have irregular income (he’s a musician, I’m a writer). What we’ve done is use his money, which is less, to pay the main bills and my money mostly goes into savings. We have a buffer of cash there and take from it as needed. However, this isn’t a properly thought out plan . . .it just sort of evolved. 🙂 I like your idea of the two accounts and will be looking at implementing this soon.
Fifty percent for taxes? Isn’t that a little high? Even with the extra 7.65% for self-employed FICA, that seems excessive. I’ve always figured 30% for taxes and every year get refunds from both the state and federal government.
Once I’m forced into retirement by the layoff coming in December, my income will be irregular because I’ll have to supplement Social Security and a 4% drawdown from savings with part-time junior-college teaching. I’ll be paid during the spring and fall, when expenses are low, and then have no salaried income during the summer, when expenses are very high.
Because of the Social Security’s rules, designed to keep you at the poverty level if you start your SS drawdown before “full” retirement age (66, for me), I won’t be able to use my freelance income if I teach three-and-three; the f/l income is so unpredictable that I can’t rely on having enough to free me from having to teach one or more sections of freshman comp per year. So I’ve set up an S-corporation, which can pay me a minimum wage out of whatever I earn, keeping the rest in the corporation; this will allow me to maintain enough work to keep my business on life support until I can again earn a living wage, at age 66.
It’s going to be very difficult dealing with the erratic income PLUS the erratic expenses at a time when my income will be cut in half. My plan is to stash a substantial cushion in my “personal” (i.e., spending) account, and then to base my budget on the average monthly expenditure, figured over a year. In the summer, I probably will eat into the cushion, but in the winter (very mild here: usually no need to turn the heat on, and you can grow a lot of food in the backyard) I should catch up.
All income from all sources will go into what you’re calling the “business” account (I call it a “pool”), and then enough to cover the budgeted expenses will go into the “personal” (i.e., “spending”) account.
I hope the worst will be over in 18 months, when I hit 66. If my health holds, maybe by then I can find better-paying work. Since at that point I’ll be allowed to earn more than $14,000 without having Social Security confiscated, maybe I can work hard and do some catch-up between 66 and 70, by which time I figure I won’t be good for much more labor. With any luck, too, maybe some funds will have accrued in the S-corporation, which I’ll be able to take as dividend income at the end of each year.
I’m also planning, like Craig (55), to pay myself the S-corp’s required “salary” on a quarterly basis, at tax time.
I’ve always lived on a variable income and as a result am extremely frugal. Any income above my bills is immediately put into savings to “help” the next month! This unsteady income is a way of life for me and will become more so as I develop a freelance business. I’m a music publicist and have found freelancing (with two full time clients on my roster) less stressful (I was a booking agent). The only reason I’m able to do this is through joyful frugality.
JD like you I feel isolated at times because it’s just me in the office. But blogs like yours, twitter friends and facebook help me not feel so alone!
I am a bartender and as such, my income varies month to month. It took a while for me to get to where I am in regards to my budget, but basically what I do is this:
For example, this month, July, I have saved every dollar that I have earned and haven’t spent a dime of it. The last day of the month I will sit down and comprise my budget for the month of August with the known amount of income that I earned in July. After all the necessities and minimum payments are paid (I am still in debt) I then know how much money I have left over for discretionary categories and debt snowball. I zero-balance the budget and the August budget is done.
I also have both an Emergency fund AND a buffer in my checking account that is not shown on my budget spreadsheet. The buffer is for months in which I may not earn enough income to cover necessities in the budget and minimums. Since it is known that this may happen, it is not an emergency, which is why I have both the EF and the buffer.
In essence, I must budget differently for each and every month since the income varies. Everyone I know knows that if they want to get together for dinner or throw in money for a gift or whatnot, I need to know about that by the last day the month prior so I can plan for it with the budget. Some months I just can’t do it, but if I don’t know by the time I have my budget meeting it isn’t going to happen because I have already spent all my money for that month by the 1st or I have it set aside for groceries, gasoline, etc.
It is my goal to one day be a year ahead of expenses with 12 months of minimum expenses in an emergency fund and 6 months of minimum expenses in a buffer fund in the checking account. That way, if say I lose my job, I am not only covered for 18 months with the Emergency and buffer funds, I already have the income for the year at the start which buys me more time to adjust and find another avenue of employment and if some months are leaner than others it gives me an entire year to average out the difference rather than being stressed out at night, not being able to sleep because I am worrying about whether I will be able to pay the bills at any point in time.
I have to agree that this is a fairly simple concept, but it makes perfect sense. I tried a similar system in the past and it worked well. The hardest part is having the will to leave the “business account” alone, but if you can do that, this is a smart way to mantain a realistic budget.
I disagree that most couples/families cannot live on one person’s income. People used to do this as a matter-of-course, and plenty of us are still doing it. Unfortunately, too many people have come to expect that certain things are an inherent right such as: a large house, new cars every four years, regular vacations.
My family has lived on my husband’s income for over 25 years now, since I had our first child. Has it been easy? No. Have we done without a lot of things we see double-income families having? Yes. Do we regret our decision to “make do?” Not for one minute.
I wish someone had told me that we should learn to live on just my husband’s income when we first got married. If we had used my income at that time for getting out of debt and putting together a rainy-day fund, we would have been in a much better situation when we did start having kids.
I have told my daughter (and she agrees) to never get married until her prospective husband can support a family; and to live on his income from day one and use her income to save for a house, build an emergency fund, etc.
My sons are not even allowed to consider dating a girl until they are in a position to support a family. They are focusing on their educations and preparing for life, not just “screwing around.”
This isn’t just for freelancers. My husband and I are both in “tip” fields (restaurant and spa). Since we can’t guarantee what our income is each month, I base our budget on our minimum expenses. Anything we make over that goes for a small amount of fun (like a happy hour out) and the rest goes into a savings account for the lean months. If the savings account gets high enough for us to pay off a debt, we sit down and decide if we can do that without endangering our monthly billpay.
I am an IT consultant freelancer, and I usually get $16,000 – $20,000 every two weeks if I have a contract.
I worked for 3 months last year and then went on a kind of a recessionary-induced sabbatical.
For the times without a contract (like now), I live on a basic amount of $700/month, off the money I made last year in a couple of months.
And I spent around $1200 a month on average, as I have been travelling a lot this year to take advantage of my time off.
I don’t really budget anything, I just try to cut back on my expenses as much as possible, on a regular basis and to sock away as much as I can when the money is flowing.
That’s about it…
I live on a very strict budget, which is basically the same amount as unemployment money would be, because I’m still in education. I worked for a year part time and didn’t spend any of the money and sometimes there is a bit more money coming in, but I generally don’t count these extras in. So, slowly there is some money accumulating in my bank account of which I’m usually not even aware and I use it to pay flights and anything “out of the ordinary”. Calculating the lowest income sounds like a really good idea and that’s what I’ve been doing the last few years!
This is a great post! We’ve had to adjust to my freelancing editing and blogging and my husband’s salary. It’s not easy for families, especially when one of our top priorities is to keep our kids in parochial school.
We economize: we buy cheaper cuts of meat and use the slow cooker to cook them, we buy fewer processed foods and I make more things from scratch, we find free events to go to as a family, we’ve dropped expensive activities, and I’ve taken a job at the mall. Sure the hours stink if I want to sleep and the pay’s low, but it helps us squeak through those uncertain times. Our new motto: you gotta do what you gotta do.
I’m much happier now than when I worked the good-paying corporate job, and the extra time with the kids makes it all worthwhile.
All great tips on variable income budgeting. I especially like the idea of the minimum monthly income and not increasing lifestyle when you have a good month.
My income can swing by as much as 50% in a month, but we still do the same things month to month and don’t go crazy when the paycheck is good.
I recently wrote a post also on budgeting on a variable income that might provide some additional insights. http://bit.ly/JsVxhP
Nice observation, thanks for pointing that out.
I usually have a steady, or regular irregular income, but some months is brutal.
This will help me and my wife allot, we have been wrestling with the idea of how to budget for it.
Andrew
it´s not easy to live on a irregular income. i do just as la toya says – i pay myself as if i would be an employee. a business needs time to grow so we need patience, unfortunately
Great list, may I just add, I think everyone should have discipline first when handling money. No matter what age we all need to know that we can face a financial problem at any time. We have to set our mind into saving a percentage of our check no matter what, and to achieve this we need to have discipline other wise we’ll just form part of the big percentage of people who don’t know how manage their money and blows it up the first pay day.
Another great post. A lot of people who are trying to break out of the 9 to 5 job pattern and making money online find the irregular nature of income kind of scary. A post like this will surely provide proper guidance on how to plan their income better. Thank you J.D.