How to budget with irregular income has been a question I’ve been asking myself for YEARS. I’ve been self-employed almost exclusively since 2005 and dealing with variable or irregular income, and how to account for it from month to month, has been a constant thorn in my side.
Part of me wants to just suck it up and go get a job at a firm with a regular paycheck. Having a set amount of income each month would be a whole lot easier than the queasy stomachs I get at the start of each month, not knowing how I will have enough money to pay the bills.
But then, something miraculous happens. I do have enough money to pay the bills, and life goes on.
Until the first of the next month, that is…
During the past several weeks, my Wife and I have gotten back onto the YNAB train. As a result, we’ve started looking much more carefully at our budget and how we spend money every day. Small purchases that previously seemed inconsequential are now scrutinized. Every expense is questioned and discussed.
But here’s the problem, I don’t have a clear picture of what our spending is… yet. And that’s because my income is so irregular that I’m not sure whether we are putting off expenses because this is a “tough month” or if we just generally don’t need certain items.
With YNAB, the idea is to give every dollar a job. But what do you do when you don’t have enough dollars for all the jobs you have for them to do?
That’s the point of this post.
How to Budget With Irregular Income
Before I get into how to budget with irregular income, I thought it would be helpful to define exactly what irregular income (also known as variable income) is.
You know you have irregular income when your income has one or more of several characteristics:
- The rate of your pay varies
- The frequency of your pay varies
- Both the rate and frequency of your pay varies
As a self-employed lawyer, the frequency of my pay does not vary, but the rate of my pay does vary quite a bit.
At my law firm, I follow the “Profit First” method. If you aren’t familiar with this technique, it’s basically the idea that I take a certain percentage of every dollar in revenue from my firm and pay it to myself as “owner’s pay”. There’s more to it than that, but basically, I pay myself a couple of times a month by taking 50% of the revenue generated from my firm. (I also set aside money for taxes and a profit account).
So if my firm generates $10,000 in a given month, I will pay myself $5,000. If we generate $20,000, then I will pay myself $10,000. If we generate $5,000, then I pay myself $2,500.
So now that you see how my income qualifies as “irregular”, let’s talk more about how I budget for irregular income.
Who is Most Susceptible to Irregular Income?
Much of the working population gets a steady paycheck. But I would guess that many more people do not. Here are just a few of the professions and categories of people who may need more information on how to budget with irregular income:
- Small Business Owner
- Independent Contractor
- College Student/Grad Student
- Commission Based Sales
Do you fall into a category that I missed? Please leave a comment below and let me know!
Determine Your Baseline Income Needs
The first step towards figuring out how to budget with irregular income is to determine your baseline income needs.
This is the minimum amount of money you need each month to pay for all your necessities, such as your house, utilities, food, etc.
No frills, no extra fluff, just your bare-bones expenses.
Here’s what that looks like for us:
- Mortgage = $1,960 (and this is going to go up next month as we are now adding 1/12 of our payment to each monthly payment to pay down our mortgage faster)
- Utilities (Water, electric, gas) = $300
- Car Payment = $231
- Groceries = $1,000??? (Still figuring this out)
- Car and Personal Property Insurance = $142
- Debt Service (Student Loans) = $1,002.75
- Pre-school = $433
So our total minimum expenses = $5,068.75/month
I’ll be honest, I look at that number and think to myself, damn, how did it get that high? And in reality, it is a bit higher. Here we are at the 17th of July and we have already spent $1,382.24 on groceries so far this month. (If any of you use Costco and find that it saves you a huge chunk of cash, I would love to hear from you.)
I wouldn’t be surprised if our minimum budget was closer to $6,000 per month, honestly.
What does that mean? It means that each month, to meet our minimum monthly expenses, I have to generate at least $12,000 in revenue from my firm to pay all of our bills.
But here’s the kicker, my firm also has a base level of expenses that I have to pay each month, typically around $3,000 to $5,000. Right now my Wife is acting as my legal assistant, and she is a lot cheaper than a full-time paralegal. I could, and probably should hire someone to help me full-time. But right now, while I juggle the idea of continuing to grow my law practice with looking for a full-time position at a firm, it is not a responsibility that I want to take on right now.
Start “Budgeting” Your Income
Here’s the deal with budgeting. Most people think that they can only budget their expenses.
But that’s not the case. You can also budget your income.
Here’s how this works. Whenever you have a good month financially, you set aside some money to use for those lean months when money is tight.
Your first goal should be to cover your “baseline” expenses or your “immediate needs”.
So for me, our goal would be to set aside $5,000 to $6,000 into a savings account that we can draw on when we have a bad month. Ideally, we would have two or three months saved up. (In reality, we do, but I will be funding my SEP IRA with this money in September, so we will need to build that account back up in the coming months).
This is one of the ways that I use my “profit” account that I mentioned earlier. I set aside 5-10% of the income generated from my law firm and put that money into a separate profit account to draw off of when income from the firm is tight. But here’s the deal with this account – it’s at another financial institution and takes several days to access if we need it.
I do this intentionally so that we really have to think long and hard before drawing money out of that account.
How to Start Budgeting Your Irregular Income
In the beginning, your budget may be tight. It’s going to be difficult, and that’s ok.
You should start with your most immediate and pressing needs. This includes groceries, gas for the car, and your rent or mortgage. Then move on to your bills and debt service.
Finally, after you have taken care of all your other expenses, you should start setting aside money for your rainy day fund. This includes your emergency fund, a car replacement fund, and vacation. In addition, this will include your deferred compensation category.
In fact, I would max out your deferred compensation before I contributed to any other rainy day funds.
Do you have a job that pays you an irregular income? How do you budget for the lean months? I would love to hear your story – please comment and share below.