Variable Income? You Need a PLAN!
Posted by John Draper | Filed under Budgets, Money Management
I was listening to my make-up artist, Natasha, and DOP, Adam, talking about how to manage their variable incomes. Adam is a freelancer and always has to be sure he’s got a cushion in case the bottom falls out of the camera-guy-world. Tasha is starting her own business – she a terrific clothing designer. They both have to deal with unreliable incomes and all the stress that goes with.
Whether you’re a contract employee, a freelancer, working for yourself, or working on commission, one of the biggest challenges you face is Feast-Today-Fast-Tomorrow Syndrome. One month you do really well, have enough to plan a holiday, build a deck, buy some new clothes. The next, you’ve barely got enough to make it to the 30th without racking your cards to the max.
Working with a variable income isn’t as hard as people think it is. You can still make a budget and stick to it. You can still have the things you NEED and the things you WANT. You have to have a PLAN.
First, you need to set your salary and live on it. If your work efforts bring in $2,000 one month and $6,000 the next, and you think of all that money as spendable, you’re going to run into trouble, it’s only a matter of time.
Smooth out your cash flow by deciding what your minimum monthly income needs to be to keep body and soul together. This is your Salary. No matter how much money you bring in, you’ll only transfer this amount into your Household Account for spending. The rest stays in your Biz Account. Then, in a month when you haven’t billed as much as normal, you’ll still have a whack of cash in the Biz Account so you can transfer your Salary to your Household Account.
To figure out your Salary, do up a budget that covers all your basic monthly costs: food, housing, transportation, medical, and the like. The we-can-live-without-it items like clothes, toys, and partying don’t make it to this list. However, savings and debt repayment do. And don’t forget taxes. Your second-tier budget needs like home maintenance, clothes, entertainment should also be part of your Salary, but with the proviso that if the going gets tough, these spending categories get going!
Now you could have a big fat monthly total if you’ve weighed yourself down with big fixed expenses – like that $800 a month car payment or a home that’s way too much for your wallet. Ditto if you’re carrying tons of debt. But I’m going to assume for the purposes of this discussion that if you have those things you can pay for them. (If you can’t, this may be the time to reassess your priorities.)
Next, you need to build up your just-in-case fund. The standard recommendation for an emergency fund is to have three months’ income or six months’ worth of essential expenses covered. Aside from the typical reasons to tap into your emergency fund — to pay for a car breakdown, unexpected home repairs or a root canal — you also may need to dip into it in when you’ve gone a few months with no work and have run out of money in your Biz Account.
I use the term “run out of money” advisedly. You should never have NO MONEY in your Biz Account, since the business itself has overheads you must cover: telephone costs, car payments, equipment lease costs, and the like. You should always maintain a minimum of six months’ worth of business expenses -– your Business Buffer — in your Biz Account. When you drop to that amount, you stop pulling your Salary so the business can stay afloat. That’s when your personal emergency fund will really pay off.
Remember you also have to save for the future. Since you’re self-employed, if you’re not socking away retirement savings, you’ll have a pittance when the time comes to stop working. Estimate that you’ll need 70-80% of your current income each year in retirement to set your retirement nest-egg goal.
When business isn’t booming, resist the urge to cut back on savings. Cut back on spending, but keep your savings intact since you will need them later. And stash the amount you’ve decided to save in a retirement account monthly using an automatic deduction.
Make sure you also fill the gaps in your safety net. As a self-employed person, you need to have both disability and (if you have dependents) life insurance. Base the amount of insurance you buy on what it’ll take to cover your basic expenses, keeping in mind that some disability policies replace only up to 60% or 70% of your earnings per year.
Use gravy for other goals. Whatever you have in your Biz Account — your Business Buffer and earnings beyond your Salary – should be invested in a high-yield account. If you’re doing very well financially, you can now decide what other goals you want to accomplish (like the deck, a vacation, or a shopping spree.) Build or replenish your emergency fund if you’ve dipped in, and pay down your debt. But you should also have some fun.
Being self-employed brings loads of terrific benefits along with some very interesting challenges. I’ve been self-employed for about 30 years – some lean, some luxurious. And I wouldn’t swap for one minute the flexibility self-employment offers, no matter how hard I had to work when things were busy. There was one period where I worked 17 hours a day, 7 days a week for about six months. I literally rolled out of bed and to my computer, rolling back in to sleep. I had no life. I made a LOT of money. And a good thing too. Because when it came time to have my kids, because I was self-employed I wasn’t entitled to any mat leave benefits. But I had a whack of cash set aside. See what you can do with a plan?
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September 11, 2008 at 11:36 am
I am a freelance Grapic Designer. I work from home and my overhead is basically phone, high-speed internet, a website and the occassional software or hardware upgrade. Not too bad really.
I have done MOST of the things listed here. I figured out what my minimum income should be to cover business and home needs, and I only draw a small wage from the business (ensuring things like upgrades and taxes are well covered). The only thing I was surprised about is the saving thing you mentioned. I have been putting away a minimum of 10% of my business’s net income every month…. so on lean months it isn’t much and on booming months it is more. After the taxes are all settled, I usually slap a bit more into long-term savings or even a lump sum mortgage payment if the year was particularly generous.
(note: My husband has a steady salary, so he is the one that puts the regular pre-auth RRSP contributions in, I just top it up with my 10% whatever that amount may be.)
September 11, 2008 at 1:31 pm
As a freelancer with very low overhead costs, I’ve found my biggest financial challenge to be setting aside sufficient tax money *in years when my income increases significantly.*
After faithfully paying quarterly installments based on my most recent tax return, and trying to set aside enough to cover the tax on the additional income (*and* keeping RRSPs maxed out to soften the hit — using even more cash flow in the process), I’ve found myself whacked at year’s end more than once, though fortunately without taking on debt for more than a couple of months.
In other words: Even though I knew a big tax bill was coming on April 30 I kept underestimating just how big it would be. This year should bring another increase, so we’ll see if I manage to prevent the problem this time. I am trying!
If your annual income ever plateaus, it should become second nature to keep tax accounts in perfect standing: there’s really no excuse to be caught short on an installment due date or April 30. If it’s growing, take more time than I did to figure out how much extra you’ll need…and set it aside.
March 5, 2009 at 11:40 am
Some of this information is helpful for my husband’s situation, but he is a seasonal worker with a bit of self employment on the side. He’s in the construction business, like many others are, and also does some guitar technician work on the side. He’s usually laid off for about four months in the winter. If you get a chance to write a blog on seasonal workers, I would love it!
Thanks for all your great advice!!
December 9, 2009 at 1:54 pm
Damn, I just posted this huge comment and then when I clicked submit the dang page when all white, does this mean I have to type it out all over again guys? I hope it’s not lost for good, that took me a long time to type out…uhhh.
February 28, 2010 at 10:09 am
My husband is also considered a ’seasonal worker’ but for the past while, we have been blessed with him working without a lay-off. Due to the fact that that is always a possibility, and remembering when we have been in very tight times before, we tend not to spend a lot of our income. However, when our income becomes the tightest, (his hours decrease, or he has to take a job at 85% of his income), that is when I go out on a spending spree! I know, it doesn’t make sense. I guess my reasoning is, to prove that we’re okay, and are going to be okay. I don’t spend on credit, it’s covered, and once it’s out of my system, I am good to go back to our usual thrifty habits. At work, I once even got the “Get Laid” award — my husband got laid off, and I went and bought a ‘new’ bedroom set. Nuts, and I know it’s nuts, but, it hasn’t gotten us into trouble yet, and I’ve had no regrets….