As a freelance writer, I understand the vagaries of living on a variable income. It’s a boom-and-bust business, and some months, my family has more than enough. At other times, we’re barely squeaking by.
Living with a variable income makes it hard for me to satisfy my Type-A-personality need to carefully budget all of our spending before the month starts.
If you’re also having trouble budgeting for your variable income, here are three popular options for creating a workable, variable-income budget:
1. Pay yourself a salary
If you’re operating a micro-business with few business expenses, you don’t necessarily need a separate business checking account. However, with a variable income it can be helpful because it keeps you from spending your overflow on good months.
To use this budgeting technique, set up a separate checking account for your business. This is what the IRS calls a “draw account” – a business account from which you’ll draw your paycheck during the year. When you get any business income, put it into your business account.
You can also use this setup if you’re paid a salary plus commission from a regular job. Instead of setting up a true business checking account, you’ll have your checks deposited into a separate personal checking account. Then, you can set up automatic withdrawals from the account twice a month – the first and the 15th work well for many. These monthly withdrawals will be a set amount, and they’ll go to your regular account. A free online checking account is ideal for this because they typically pay interest and make transferring money between accounts really easy.
To figure out how much to take out of your business account, you need some idea of how much you’re making in an average month. You can get a rough estimate by adding up your income from the last 12 months and dividing by 12.
(Hint: I would use the income from the last 12 calendar months, not the last tax year. That will give you a more accurate idea of what your average monthly income is to date, especially if business is booming or declining recently.)
On a good month, you’ll have some money left over in your account. Leave it alone. It’s there as a pad for the months when you might not make enough to cover your set paychecks. If you have several good months in a row, you can transfer some of the extra money into retirement savings, put it toward a big purchase, or just spend a little for fun, if you like.
Pros of paying yourself a salary
- You can create a monthly budget as if you have a fixed income.
- You won’t have to worry as much about rough months, because you’ll still have money to cover your budgeted expenses.
- You’ll automatically save extra money so that you can use it more wisely, instead of blowing it month by month.
- If you’re an entrepreneur or sole proprietor, a separate checking account can make it easier to track business expenses if you pay business-related items only out of that account.
Cons of paying yourself a salary
- In the beginning, it can be hard to determine how much your salary should be.
- If you have a really rough month before you build up your business account, you may not have enough to pay your full expected salary, which can throw off your budget.
2. Prioritize monthly spending
If you’re basically living hand to mouth on your variable income – or if you don’t want to mess with a detailed budget – prioritizing your monthly spending can work well. This is the route advised by people like Dave Ramsey, who would urge you to kick any extra money in one month toward paying down debt or into savings or investments.
(Ramsey offers a nice little irregular income planning worksheet if you decide to use this method.)
With a prioritized spending plan, at the beginning of the month you’ll make a list of bills and expenses, most important to least important. The key here, especially if you’re behind on payments or struggling financially, is to know what’s really most important.
The main expenses to worry about on a very lean budget are the ones that will keep your family fed and sheltered and the ones that will keep you working. Here’s a basic breakdown of items to be most concerned about:
- Essential utilities (this does not include the bill for ESPN or Hulu!)
- Mortgage or rent
- Childcare (if you need it in order to work)
- Essential clothing
After that, you’ll need to list other set bills – health insurance, credit card payments, student loan payments, etc. At the end of the list, include things you want but don’t necessarily need – savings, your cable subscription, a gym membership or whatever.
Then, you pay your expenses in the prioritized order as you get the money to do so. Set aside money for food first (either for the whole month or until the next paycheck, depending on your preferences), and then pay your utilities and mortgage.
If that’s all you have money for, stop there until you get more. When you get another check, pay your car payment, or fill the gas tank. Sock away some money for your next oil change, or write the daycare provider a check.
In a good month, you’ll get to all the essentials and have some money left over to save for a bad month or to put toward short- or long-term savings. In a bad month, you may have to do without a few non-essentials to make ends meet.
This can be a stressful way to deal with your variable income, but if your income is variable by hundreds or even thousands of dollars a month, it may be the best way to get started.
Pros of a prioritized spending plan
- It helps you to spend money where you need to most, so you’re using your limited income wisely.
- You can implement this plan without an earnings history. This is great for those just starting to live on a variable income.
- It helps you get more control over your income and expenses if you’re living on a very tight variable income.
Cons of a prioritized spending plan
- If you spend all your income each month, you may have some months when you can’t pay all your necessary expenses, leaving you behind on bills.
- You may struggle with due dates. In this case, you may end up paying some items out of order so that you don’t miss a due date.
3. Live on last month’s income
This final option for living on a variable income builds in the most breathing room, but is the hardest to set up in the beginning. Popularized by You Need a Budget, living on last month’s income is a solid option.
The YNAB guys recommend this option for everyone, even people on a fixed income. But it’s most helpful if you don’t know what you’ll make from month to month.
To get started with this budgeting technique, you’ll save up one month’s worth of expenses. Not sure how much money that is? Look through your spending for the last few months, and add up what you have to spend to pay for one month’s essentials.
Let’s say $4,500 is your number. To start, you’ll save up $4,500 as quickly as you can. It may take a few months, but it will be worthwhile if you plan to use this budgeting option.
Say that as of June 1, you have $4,500 in savings (or as extra money in your checking account). Create your spending plan for June based on that amount. Don’t spend a dollar more than the $4,500 you had at the beginning of the month.
While you’re spending the money for the month, let your paychecks for June roll in. Whatever they are, don’t touch them. By the end of the month, you will have spent (or put into savings) all the money you had June 1. But instead of being empty, your bank account is full of the money you made throughout the month of June.
Now starting in July, you’ll create a budget based on what you made in June. $5,000? Great! You’ve got a lot of extra cash to save and play around with. $4,200? You’ll have to cut back your spending in some areas to stick to what you’ve made. But in July, you’re spending June’s money and saving anything you make in July.
In this way, you build up a cushion of extra cash in your checking account, which is great if you had been emptying your checking account to pay bills. Plus, you’ll always know what you have available to spend in a given month, because it’s already in your account on the 1st.
Pros of living on last month’s income
- It lets you work with your variable income one month at a time, instead of having to forecast what you’re going to make.
- Since you know exactly how much you’ll have to spend that month, you can decide ahead of time where to cut back or where to spend extra.
- You can pay all your bills at the beginning of the month, if you want.
- You’ll have a cushion for emergencies. (You can pay for a June emergency with June’s income and then figure out how to take it out of July’s budget later.)
Cons of living on last month’s income
- It takes time to save up a month’s worth of money so you can get started.
- There may still be months where your income drops too low to pay all your bills.
It’s All About What Works for You
All three of these budgeting options are good in some situations. But the truth is that a combination is the best bet for most people who live on a variable income. For instance, you might pay yourself a salary but still prioritize your spending for months when you don’t make much.
Also, if you have a partner or spouse who makes a set income – or if you work a day job alongside your variable-income gig – you can combine these options with more traditional budgeting techniques. For instance, pay for basics with the set income and make a prioritized list of how you’ll use your variable income as it comes in.
The key is to play around with the options to figure out how you can best manager your variable income. Do you have any other ways you deal with income variations?