Wednesday, April 20, 2011

How to Budget with Irregular Income

It can be difficult to know how to budget with an irregular income.
This is the second part in a three part series on budgeting.  To read part one, go here.  And stay tuned tomorrow for the best tools for your budget.
Budgeting with a variable income is a problem that many people have, and I don’t think it’s covered adequately in most personal finance books.  The headache that comes with trying to budget when you don’t know what your monthly income is going to be is the single biggest reason I’ve failed at keeping a budget over the years.
My husband has worked in various commissioned sales positions for most of our 12 years of marriage, so I’m not new to dealing with irregular income.  Freelancers and those who are paid by the hour also have income that can vary widely from month to month.
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.
Keeping a budget is the best way to even out the highs and lows of a variable income.  Though it’s true that budgeting is more complicated when you don’t have a steady income, it is possible to make and keep a good budget.  And I’m going to show you how.
On Monday I showed you the steps to creating a budget.  You are going to follow the same steps, so you might want to review that post.  I’m also going to add a few steps.

Estimate Your Monthly Income

If you’ve been working with an irregular income for a long time, take last year’s income and divide it by 12.  If last year was a typical year, that is a pretty good estimate of how much you’ll have to work with on a monthly basis.
If you had a great year last year, cut the number down to what is typical for you.  It’s much easier to adjust your income up after you’ve started your budget than to continue cutting expenses.
If you work on base salary plus commission, see if you can live on just your base salary.  Any commission can be used for paying down debt, saving for a house, or whatever you please.
If you’re new on your job, your employer probably told you what a typical first year salary is.  Estimate your income lower than that.  It’s been my experience that new employers are a little bit too optimistic on your initial earning potential.  If you end up making as much as your employer said you’d make, you’re money ahead. 

Plug in the Numbers

Now that you’ve estimated your monthly income, use that number to budget. Follow the steps in my post How To Make a Budget That Works, until you have a good budget. 
And please fight the temptation to adjust your monthly income upward, because you’re having trouble making the budget work.  That’s setting yourself up for failure.  Keep cutting expenses until the numbers work.

Set up Two Bank Accounts

The first bank account should be a high yield savings account (I recommend ING Direct).  You may as well earn interest on your money.  When you get paid from your employer or your clients, deposit the money directly into your savings account.  You are going to pay yourself out of this account.
Decide whether you want to receive a "paycheck" once or twice a month.  I prefer twice.  On the first and the fifteenth of every month, transfer 1/2 of your estimated monthly income to your regular bank account.  Even if you made more money that month, transfer only that amount.
What you are doing is giving yourself a regular salary.  On months that you make more than your "salary", you will be leaving the extra money in the savings account.  On months where you make less, you will use the extra money from the good months to cover the difference.
At the end of the year, if you have a lot of extra money in your savings, you can give yourself a small raise for the next year.  If you’re consistently finding that you don’t have enough money in your savings account, you may have to give yourself a pay cut.
This method can take six months to a year to start really working correctly.  You will have to make adjustments, but stick with it as best as you can.  Eventually your budget will work the way it’s supposed to, and you can say goodbye to the roller coaster that comes with a variable income.
Don’t miss the other posts in this series!
Have you successfully used a budget with a variable income?  How did you do it?

No comments:

Post a Comment