Budgeting as a couple is challenging under the best of circumstances. How do you budget when one person is self-employed? Here’s one approach.
Budgeting is fairly easy when both parties are salaried and have consistent income streams. Simply account for your incomes, deduct your recurring monthly expenses, automate savings and investments, and you’re pretty much done. Easy, right?
However, budgeting gets tricky for couples when one (or both) of them has an irregular income stream. Budgeting is even harder when one party is salaried and the other is self-employed. If you’re not careful, you can really lose track of your cash flow. If this happens, you’ll wind up with a confusing mess of a budget that just doesn’t work — or, worse, gets abandoned altogether.
Here are some specific techniques that couples can use to budget when at least one of them is self-employed. These tips also work well in other irregular income scenarios, such as when someone works on commission or is a freelance employee.
First, Make a Plan
If you’ve never developed a budget before, the idea might seem overwhelming at first. As with any complicated task, breaking it down into smaller, more manageable chunks is extremely helpful.
For this, we will develop both a joint budget and two additional budgets, one for each party. To make it easy, let’s assume there is one joint checking account, and each party also has a separate checking account, into which each party’s income is deposited.
For the joint budget, list all the common household expenses required to run the household. These may include…
- Health Insurance Premiums
- Dental Premiums
- Health insurance deductibles/copays
- Life insurance
- Disability insurance
Joint Savings to fund:
- House repairs
- Car repairs
- Joint vacation fund
Decide how to fund the common expenses. If both parties earn about the same income each year, perhaps you simply divide the total joint expenses in half. What if one person earns twice as much as the other? In this case, you may prefer to divide the total joint expenses by three. Then, have one person pay two-thirds and the other person pay one-third.
For the salaried party with consistent income, it’s assumed that their regular paycheck will be deposited into their personal account each pay period. Then, you can simply set up an automatic transfer once or twice a month. Have your bank draft from the personal checking account into the joint checking account to cover that party’s share of the joint expenses. That’s pretty easy!
For the party who is self-employed, though, “payday” looks a bit different. For them, the net of business income minus business expenses is transferred into that party’s personal checking account each month. From there, his or her share of expenses should be transferred to the joint checking account in order to fund the joint household expenses.
If the income stream is lumpy and not earned in consistent, equal monthly installments, you may need to rely on savings to fund the shortfall for joint expenses. Of course, it’s very important in months of surplus to replace the money borrowed from savings.
Reimburse as Appropriate
It’s very common that one person funds certain joint expenditures. These need to be taken into account when calculating one’s contribution to the joint account.
For example, if family health insurance is funded through a payroll deduction from one party, then that amount should be deducted from his or her contribution to the joint account.
Step 3: Create Individual Budgets
For the salaried party, start with their paycheck’s gross salary. Then deduct :
- Retirement savings
- Payroll deductions (e.g. health insurance).
- Contribution to joint checking defined above, less any joint expenses funded individually – e.g. family health insurance.
- Spending money (non-joint food, entertainment, etc.)
- Personal savings
For the self-employed party with a single-member LLC, the net of business income less business expenses passes to the individual. However, he or she could look at average business income and get a rough idea of what to expect in the coming months. From there, they can develop a personal budget as described above.
It may be easier to work in percentages, as well. Rather than saying “I will put $450 in my Roth IRA this month,” he or she could say, “I will put 10% of my income in my IRA.” This way, a budget plan can be established while still accounting for the ups and downs of self-employment income.
For the salaried party, the tax burden is simply listed on their pay stub and automatically deducted. For the self-employed party, though, the net of business income less expenses flows to the individual’s tax return.
A self-employed person has different taxes than a salaried employee, and that should certainly be taken into account when developing your budget.
Often, taxes are paid quarterly, which adds to the lumpiness of the income/expense stream. Be sure to plan for these tax bills, whether paid quarterly or annually, and tuck that money aside on a monthly basis. That way, you’re not stuck writing a painful check to cover a tax bill for which you haven’t been budgeting.
For the salaried party, it’s common to save a percentage of gross wages for retirement through an IRA, Roth IRA, or workplace-sponsored 401k. For the self-employed party, retirement savings can be accomplished through a Roth IRA, SEP IRA or SIMPLE 401k.
An SEP IRA is a type of traditional IRA for self-employed individuals or small business owners. (SEP stands for Simplified Employee Pension.) Any business owner with one or more employees, or anyone with freelance income, can open a SEP IRA. Read more about SEP and SIMPLE 401k plans here: http://www.investopedia.com/articles/retirement/04/060904.asp
Even though I’m discussing a three-budget solution for the household, it’s important to agree on retirement and other savings objectives as a couple. One party shouldn’t save 30% of their income while the other party saves only 5% of theirs. The dollar amounts contributed may not match, but the percentages ideally should.
When arriving at savings objectives for the self-employed party, don’t get confused by the gross income for the business versus the gross income for the individual. The business owner typically takes some (or all) of gross sales, less “cost-of-goods-sold,” less expenses. Often, a business owner takes little or no salary in the early years, as the business is growing. It’s important to discuss and agree on this as a couple, so you know what to expect for your personal finance situation.
Get the Lumps Out!
With so many moving parts, it’s easy to get overwhelmed. This is especially true with items that are paid quarterly or annually.
For items that are paid annually, it’s helpful to set up automatic transfers into a dedicated joint savings account. For example, let’s say real estate taxes are $2,400 per year, and each party is contributing equally to household operations. In that case, each party should contribute $100/month to the joint account for taxes. Then, automatically transfer $200/month from joint checking to joint savings. When it comes time to pay the tax bill, the $2,400 is safely there, and no one feels the pinch!
To avoid commingling, consider setting up multiple savings accounts for different purposes: e.g. tax fund, new car fund, vacation fund, etc. Many banks allow you to easily set up a number of free sub-accounts, which you can categorize or name however you’d like.
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A key to long-term financial success is spending less than you make and investing the rest. Having a realistic plan and sticking to it is important to that end… even more so when a couple’s income is unpredictable in any way.
Just as you wouldn’t depart for a cross-country journey without a road map, don’t embark on your financial journey through life without a budget!