Budgeting is essential for anyone who wants to keep track of their finances, understand their spending habits, or ensure they have enough funds saved up for future big purchases, to pay down bills, or to retire comfortably. That’s relatively easy to do when you earn a set amount each week, month, or year, as you simply deduct your expenses from your earnings to decide how much you can set aside for other things.
Budgeting with a variable income is challenging, however. It’s next to impossible to accurately determine how much money you have coming in weekly or monthly, but you still need to budget every month to pay your bills. A little financial planning can help you learn how to budget your income — even if it changes regularly — and put money away for savings.
What is Variable Income?
Variable income refers to any earned or unearned income that you don’t always receive in the same amount every pay period. The amount changes from payment to payment — unlike more traditional set payment schemes — and includes fees, perquisite, overtime pay, allowances, gratuity, bonuses, commission, fringe benefits, and other remuneration related to an individual’s employment.
More than 21 million Americans earn variable income, according to a 2017 report. Occupations and side hustles with variable income include independent contractors, contingent (temporary) workers who use temp agencies, on-call workers without regular hours, freelancers, and those who are employed through contract firms.
6 Tips for Creating a Budget with a Variable Income
As a non-salaried worker — a freelancer, solopreneur, contingent employee, or seasonal business owner — you need to build a realistic, sustainable budget despite your irregular income. The following tips will help give you a framework for where to start that process.
1. Determine Your Non-Discretionary Spending
Start by adding up all your non-discretionary spending to form your budget baseline. For the most part, non-discretionary expenses are fixed and non-negotiable. These include:
Includes rent or mortgage escrow payments (principal and interest, homeowners insurance, property taxes, or homeowners association dues)
Bills for electricity, heat, water service, cell phone, cable, and home internet plans
What you spend on food, excluding restaurant and other discretionary purchases
Public transit fares, fuel, or maintenance expenses
Premiums for auto, health, life, and renters insurance, among others, as well as contributions to flexible spending, health savings, and other tax-advantaged accounts covering non-discretionary expenses
If you are not subject to tax withholding, you may have an obligation to make either quarterly estimated tax payments or opt for a lump-sum amount during the tax filing deadline (with a fine).
You can also include your partner or spouse’s income and expenses into your budget if you have merged finances.
2. Determine Your Average Monthly Discretionary Spending
Estimate your average monthly discretionary spending, such as entertainment costs or meals at restaurants. Look back through at least 12 months of statements and bank account withdrawals. Add up the total amount and divide that by the number of months. Trim these expenses if you find that you spend too much on them.
3. Determine Your Average Monthly Income
Calculate your average monthly income. Only account for actual income, not pending commissions or invoiced payments due. Pour over your bank statements and add your partner’s income if applicable. Divide the total amount by the number of months in your review period.
4. Set Aside Savings
Always set aside savings. Non-salaried workers face more significant financial uncertainty than those with the protection of a traditional employment arrangement, meaning saving for the future should become a priority. You can set aside funds from your gross income or treat savings as non-discretionary expenses with higher priority than discretionary ones. If you contribute to several savings accounts, assign each a priority level. Additionally, always save the excess amounts, bonuses, or periodic windfalls such as annual tax refunds.
5. Pay Yourself
Pay yourself a salary drawn from your previous month’s income and based on your total expenses, and deposit the amount into your day-to-day spending checking account. You can also deposit the money into the account you use with a credit card. It’s best to set a salary equal to your lowest monthly spend and later adjust your discretionary budget accordingly.
6. Build an Emergency Fund
Your emergency fund should hold enough money to replace three months’ worth of expenses, and the ideal fund doubles that. As a worker with a seasonal or irregular income stream, you are particularly vulnerable to financial uncertainties and strain. If your emergency fund has insufficient funds, prioritize that reserve over other goal-oriented or long-term savings accounts.
What to Know about Variable Income
You should always report your actual monthly income and any significant changes to it (anything over $150 monthly) to avoid paying more during tax time. Here are some other facts that may be helpful:
- You can also average your monthly income over a period.
- If you receive extra tax credits than what you are eligible for, you may have to pay the money back when you file taxes.
- The U.S. pay-as-you-go tax systems mean that people with variable income must manage quarterly tax estimates and payments.
- You have to make estimated quarterly payments if you expect to owe the Internal Revenue Service (IRS) $1,000 or more when you file your return.
- Expect a penalty for late payments or failure to pay enough, even if you have a tax refund.
The exact amount to pay is dependent on your tax bracket at the time plus other eligible credits and deductions. IRS Form 1040-ES can help with the calculation, or you can use the safe harbor method to pay 90% of the tax you expect to owe for the year or 100% of the previous year’s taxes. Use an annualization income installment method if your income rises dramatically later in the year.
The Benefits of Hiring a Wealth Management Professional
A variable income is a budgeting challenge, but not an impossible one. With enough financial and cash flow planning, smart money management, and discipline, you can learn to deal with any ebbs and flows that come your way — and working with an expert can help. Wealth management can be an integrated asset and investment management solution that offers:
- Comprehensive strategic financial planning
- Investment management
- Tax preparation, optimization, and planning
- Estate planning
- Cash flow planning
- Retirement planning
- Real estate investments
- Risk management and insurance review
The team of financial advisors at Bogart Wealth has a lot of knowledge and experience with financial planning. We listen to your goals and pain points before assembling the right strategic options and financial instruments to offer you the financial freedom and management you want. Contact us today to speak with an expert about variable income and any other financial issues you might have.