How to Budget on an Irregular Income

Earning a variable income is commonly associated with self-employed individuals like freelancers, contractors, and business owners. While this category accounts for more than 16 million Americans, some employees also need to navigate earning an irregular income, including sales professionals and service workers.

Successfully managing your finances on an irregular income can take a little extra work, and you won’t always be able to follow the usual advice offered to salaried workers. As we work up to building a complete budget, let’s start with five key tips to keep in mind for variable earners.

5 Tips for Managing a Variable Income

Tip 1: Build up an emergency fund

An emergency fund is a pool of savings that’s separate from your standard retirement accounts. It’s meant to be used for major unexpected expenses like vehicle repairs or medical bills, as well as to cover periods of reduced income or unemployment.

While fixed earners also benefit from building an emergency fund, having extra savings on hand is far more critical for variable earners. When income is lower than projected, an emergency fund can be used to make ends meet. Moreover, in most cases, self-employed individuals (who constitute many variable earners) are generally not eligible for traditional unemployment benefits in the United States.

Variable earners are usually advised to build a fund that can support three to six months of living expenses, but the right buffer depends on your individual situation. If your earnings are highly inconsistent, you might benefit from saving a year’s worth of expenses or more.

Tip 2: Don’t neglect retirement

Traditional employees often have retirement contributions drawn right out of their paycheck into tax-advantaged plans like a 401(k) or 403(b). But for many variable earners, these options are either unavailable or impractical.

As such, you’ll need to set up your own retirement accounts and incorporate long-term savings into your budget. For self-employed individuals, in particular, options like a SEP IRA or a SIMPLE IRA might make sense.

Tip 3: Track and understand your earnings

While we’re discussing irregular income in this article, you likely have some idea of the amount of money you can expect each month based on prior earnings. Effectively quantifying this expectation, rather than just guessing, will be key to building a useful budget.

If you can, gather and organize any historical earnings data you have, and keep that data updated with each successive month. Software like Excel or Google Sheets can be used as an irregular income budget spreadsheet to make this process faster and simpler.

Tip 4: Plan for taxes

Depending on their employment status and mode of earnings, variable earners can be subject to a number of different tax rules.

If you earn an irregular income, you might benefit from speaking with an accountant to understand how your tax responsibilities may differ from a salaried employee.

Tip 5: Be flexible

By definition, variable earners don’t have a consistent level of income. As such, it would be a mistake to expect that you’ll have a completely consistent budget each month.

If you’ve recently transitioned to earning a variable income, the idea that you might need to adapt your expenses to match income fluctuations can take some getting used to. But variable earners need to understand their income and expenses in a unique way – a topic we turn to now.

Understanding Your Income and Expenses

Like any budget, creating an irregular income budget is about balancing two things: your earnings and your expenses. Let’s start by looking at the earnings component of this equation.

Calculate your earnings

While salaried employees can pencil a fixed monthly income into their budget, variable earners need to calculate a few different figures to truly understand their income.

First, understand how much of your earned income is actually available each month. If you completed a lucrative project in January but won’t be paid until February, it would be a mistake to include the anticipated cash in your January budget. Many variable earners benefit from a cash accounting system, where only income that’s actually available counts as earnings.

Next, calculate your average monthly income. For example, if you earn $5,000, $5,700, and $4,000 in three successive months, your average monthly earnings over that period would be $4,900. As you calculate this average, ensure you’re only using months that reflect your current earning potential.

Finally, establish your minimum monthly earnings. This is an amount that you’re highly unlikely to earn less than each month. Finding the lowest amount that you earned in any recent month is a useful benchmark, but discounting this slightly to account for dry periods can be helpful.

Now that we understand the money coming in, we need to think about the money going out: your expenses.

The three layers of expenses: Core, Crucial, and Contingent

In tip 5, we mentioned the importance of flexibility in budgeting with an irregular income. In practice, this generally means recognizing that not all monthly expenses are equally important. As such, you’ll need to prioritize where your money goes.

The first bills that need to be paid are your core expenses. These are essentially your living costs, sometimes known as a “bare-bones budget.” Core expenses include:

• Food – but only essential grocery items.
• Housing and utilities, including water, heat, electricity, and your rent/mortgage.
• Transport costs that are necessary to get to and from work, the grocery store, or other essential places.
• Healthcare, including health insurance and any prescriptions.
• Other necessary insurance including auto or home.
• Dept payments – but only the minimum amount required.
• Tax payments that haven’t been withheld from your earnings.
• Work expenses that you need to pay to earn a living. This might include a phone, internet service, and any necessary apps or subscriptions.

Next up are crucial expenses. These costs are still very important, but missing them won’t have the same near-term consequences as failing to pay core expenses. In other words, you’ll only want to skip out on crucial expenses during very lean months. Crucial expenses include:

• Emergency fund savings are regular contributions designed to build up your emergency fund.
• Increased debt payments that are above the minimum included in your bare-bones budget and enough to start truly paying down your debt.
• Retirement contributions made as part of a long-term savings plan.

Finally, we have contingent expenses. These are non-essential or discretionary expenses that may improve your quality of life but can be cut without serious consequences. Contingent expenses include:

• Restaurants and non-essential grocery items.
• Entertainment and leisure like vacations or streaming services.
• Clothing and personal care beyond basic needs.
• Gifts and charity – although some may consider these to be core or crucial expenses and even beneficial for tax deductions.
• Saving for personal goals, like an expensive trip or large purchase.

Creating an Irregular Income Budget

Now that you’ve assembled an accurate picture of both your earnings and your expenses, it’s time to incorporate both elements together to create a monthly budget. One common approach is to create a zero-based budget, wherein each dollar earned is “assigned” a role – leaving zero left over.

Using the expense framework we described, any money earned would first be assigned to core expenses. Since core expenses represent your living costs, they’re generally fixed and therefore need to be paid first.

The total amount of your core expenses should be less than your minimum income, to ensure you don’t need to regularly dip into your emergency fund to survive. If you live in a high-cost-of-living area, however, you might not be able to leave much of a gap between minimum income and core expenses.

Next, the remaining earnings should be assigned to crucial expenses. Ideally, the total amount of your core + crucial expenses should be below your minimum income. Regardless, this amount should certainly be below your average earnings, or you may risk failing to reach long-term goals as a result of repeated low-earning months.

Once core and crucial expenses have been satisfied, the remainder of your income can be assigned to the contingent category. Since both this expense category and your earnings are variable, the amount you spend on contingent costs each month may fluctuate significantly.

If you’re confident in the regularity of your average earnings, you may feel comfortable “pre-spending” earnings that have yet to be fully processed, like an invoice you expect to be paid next week. But to avoid overspending, many variable earners may prefer to only spend income that has been fully realized as cash.