Budgeting / 22 March 2019, 12:00pm / Dr. Kyle O'Hagan
Over the last 3 decades, so much has changed with respect to how we work. Gone are the days of earning a fixed, steady income working a 9 to 5 job. With the 4th Industrial Revolution taking center stage, it’s not uncommon for people to work online, be self-employed or work remotely from all corners of the globe. What this means, however, is that, while we tend to have a lot more freedom, we have the added stress of receiving an irregular paycheck. How do we create a budget for this irregular income?
Below are 6 effective strategies that might help you manage (and even thrive) no matter when payday arrives.
1 | Figure out your bare-bones budget
Ask yourself – what is the bare-bones amount I can feasibly live on? In other words, what is the absolute minimum you need to meet all your financial obligations? This should include housing (rent/mortgage), health insurance, transport, groceries, monthly utilities, minimum debt payments, childcare-associated expenses, and any other expenses that are specific to your situation.
We’ll call this your skeleton budget.
Why? Because everything else in your budget is directly or indirectly affected by it. It’s your baseline. Your starting point. It’s what holds your finances upright and in good standing.
When you calculate your minimum budget, you’re essentially working backward.
How so? Well, if you’re earning a steady income, you know exactly how much money is coming in each month, right? Because of this, your needs will be determined by how much you’re able to spend. However, when you budget on an irregular income, you first figure out how much money you usually spend so that you know how much you will need each month. See the difference?
A bare-bones budget allows you to prepare for the worst-case scenario. If you run into a few bad months, when your take-home salary is lower than usual, you’ll at least be aware of the absolute minimum that you need. You can then modify what’s left over to accommodate for other expenses.
2 | Add some meat to your budget
Great. So you’ve created a budget that somewhat resembles a skeleton. Well done, you! What next?
Well, to live with any level of sanity you’re going to need to add some meat to those bare-bones. This can be any guilty pleasures that might not be considered necessary for survival, but are necessary to keep a smile on your face and a spring in your step.
Let’s be real. Living on a bare-bones budget wouldn’t be fun (or sustainable). You’d receive no enjoyment out of it and would likely end up scrapping the idea altogether.
So, then, what is this “meat” I’m speaking of? This could include things such as dining out, your Netflix subscription or the Woolworths filter coffee that you’re certain is needed to make it through your mornings. These are the pleasures that make budgeting a little more bearable and frugal living a little more fun.
I’m a big proponent of money-life balance. In order for anything to be sustainable, you need to find areas of compromise. Whether it’s a new diet that you’re following or if it’s trying to cut down on your spending, you need to balance restriction with some level of indulgence. Of course, this doesn’t mean we should overindulge. Emphasis should be placed on balance. Select a few of the pleasures that make you really happy and scrap the fluffy extras.
When you’ve decided what meat makes the cut, add this amount to your bare-bones budget and… voila… the majority of your budget starts to take shape.
3 | Manage Murphy
Never has an emergency fund been more important than if you have to budget on an irregular income.
It’s not a matter of if, but a matter of when Murphy decides to pay you a visit. And the last thing you need is the added stress of having to dish out your precious monthly income to address unexpected emergencies.
I’ve previously written about what to consider when setting up an emergency fund. In this post, I go into detail about 10 different strategies to ensure you’re prepared for when rainy days arrive. Now that you have an idea of your bare-bones budget, your emergency fund would simply require that you have between 3-6 months of this amount stashed away in a separate account.
This is probably one of the most important funds you need to set up if you have fluctuating finances. Why?
Because it will ensure that, in the event of some catastrophic event, you’d be covered for at least that amount of time while you do damage control. There is no price on peace of mind, which is exactly what an emergency fund achieves.
4 | Get a month ahead
Some experts like to call this the “one month ahead” budget. The goal is to reach a point where you have enough money saved to cover your average expenses for one month. You then allocate your spending based on the previous month’s income.
For example, if you’re budgeting for March expenses, you’d use February’s income to pay for them. In this way, you will always be a month ahead. Essentially, it allows you to be one step ahead of your finances, allowing you to prepare for future, leaner months when business is slow.
Can you see why this would be effective with a fluctuating income?
So, how do you do it? Well, let’s say that you had a particularly good month and business was booming. Ideally, you’d have extra discretionary money that you could put into savings. Collect this cash until you have enough saved to go a full month without touching your normal income.
When you’ve hit the mark, you can then spend last month’s income on this month’s expenses. While you’re doing that, you’d be earning income this month for next month’s expenses. Sounds like a bit of a tongue twister, doesn’t it? But, if you read over it again slowly, it will eventually sink in.
I like to call this your Emergency Fund 2.0 – it gets you ahead of any unexpected months when money is tight, without having to dip into your actual emergency fund to get by.
5 | Don’t forget about taxes
Ugh! I get it. No one wants to talk about the taxman. It feels like daylight robbery.
But this is important, especially if you’re self-employed or a commission earner and taxes aren’t automatically withheld each month. The last thing that you want to do is get into trouble with the law, jeopardize your business (and income) and pay penalties for non-compliance.
The best way to get around this is to calculate your estimated or predicted earnings for the tax year. This can be based on previous years’ income or by averaging a few months and extrapolating that for a full year.
Once you know this, you’ll be able to determine your taxable income and the amount of tax owed, which you can pay either in quarterly installments in the US (IRS) or over three payment periods in South Africa (SARS). This will, of course, depend on your country of residency. If you happen to pay too much, you can expect a tax refund. But, even if you happen to pay too little, at least you won’t be bowled over by a hefty return when tax season rolls around.
I highly recommend hiring a tax lawyer who can help you get started and teach you the ropes.
Also, be aware that many provisional taxpayers (who earn fluctuating income) are usually able to claim deductions on any equipment or resources that are used for business purposes. This helps to reduce your taxable income and, hence, the amount you owe. Score!
6 | Be patient – with your budget and yourself
We all know that any skill of worth takes time to learn. Rome wasn’t built in a day. Nor is your budget. Give yourself some time to settle into the habit of budgeting. But also give your budget some time to reach equilibrium.
If you’ve recently started earning an irregular income and budgeting is new to you, don’t expect it to be perfect from the first month. There will be kinks to work through as time goes by. And you’ll often get frustrated that you can’t see the results you were hoping for.
Don’t throw in the towel just yet. It’s not easy to budget on an irregular income. Be patient with yourself and your budget. Give it at least 6 months to normalize. I promise – if you stick to your guns and work through the kinks, your budget will end up being your best financial resource.
While creating a budget on an irregular income is a little more complicated than most, I hope that this article has provided some encouragement that it’s still possible. It might involve a little more engagement and tracking, but it will be worth it. To summarize:
Calculate your bare-bones budget (the minimum you need to get through each month)
Add on some meat (or unnecessary expenses) to your budget
Manage Murphy by setting up an emergency fund
Get one month ahead (spend this month based on last month’s income)
Always keep taxes at the back of your mind
Be patient with yourself and your budget
To get you started on setting up a budget for your fluctuating income, download our FREE Financial Starter Pack, which provides you the tools to get started on your budget today.
Are there any other strategies you’ve used to budget on an irregular income? I’d love to hear what has worked for you or if you’ve made any mistakes that others can learn from. Feel free to comment below.
Dr. Kyle O'Hagan is a UCT scientist and an avid personal finance blogger. With over 20 years worth of experience in the SA schooling system, he has come to appreciate the value of a proper education and feels that personal finance is an area that is often neglected, particularly at a young age.
O'Hagan is one of Personal Finance's New Voices and his finance blog is called the Saving Scientist.