Avoid Feast or Famine
There are plenty of reasons why your paychecks might not beat that steady biweekly drum — you’re a small business owner, freelancer, or working on commission, for example. And then, of course, there are those who have seasonal gigs that are lucrative only for a few months each year.
So how do you handle the ebbs and flows of this type of income? Luckily, the unpredictable nature of signing up for a flexible life doesn’t have to mean financial insecurity, as long as you create a clear budget and stick to it. Here’s how.
Know Your Worst-Case Scenario
“Figure out what a ‘low average’ income is for you,” says Sophia Bera, CFP and founder of Gen Y Planning. “It's really important to know so you can save while times are good, because there will likely be some lean months in the future.”
To do this, first track your business and personal expenses. This will tell you how much it costs to run your business (if you’re running your own) and live your life when no business is coming in (e.g., winter if your business is selling jewelry on the beach). Bera recommends using an accounting system that will make it easy for you to collect online payments and track expenses, such as Xero or QuickBooks.
Give Yourself a Salary
No matter what you’re paid by clients or a seasonal boss, stick to drawing out the same set salary. “Set up a monthly paycheck for yourself based on what you now know you need to live off,” says Bera. Then maintain this number, even if the money is pouring in, and plan to sock away the rest.
Craving a dip into your cash vault? Bera offers a safer plan: “Pay yourself every two weeks, not four.” This way you’re fronting yourself more immediate spending money but you’re still budgeting to allow for when your business accounts may fluctuate.
Divide and Conquer
Once you know the value of what you need each month at a minimum as your “salary,” divide this number into four areas you contribute to every time you get paid, says Kali Hawlk, owner of Common Sense Millennial and author of The Tax Starter Kit for Side Income Earners.
“The first category is retirement. Here, I max out my Roth IRA and my SEP IRA first,” explains Hawlk. Self-employed people, according to the IRS, can contribute up to 25 percent of their net earnings (a maximum of $53,000 for 2015). Use your net earnings from the previous year as a guide for your total contribution. Then it’s your choice: Either divide by 12 to figure out how much to contribute each month, or put in as much as you can when you’re flush and have more savings to work with to prepare for a drier month ahead. Remember, when you’re not working for a corporation that sets up benefits like a 401(k), you’re on your own.
“Next, I put money into cash savings. These are my most important ‘bills’ that must be paid no matter what,” Hawlk says.
Third, on the expense side, she pays her necessary costs, like housing, utilities, insurance, and items required to keep her business running. “Then I look at flexible expenses. These are necessary, but I have more control over how much they cost me each month — from groceries to transportation and pet expenses.”
The last category is the most frivolous and can increase or decrease depending on business success. “After that, it's everything else,” Hawlk says. “I give myself a set amount based on how much extra cash is left over to spend, and when it's gone, it's gone.” This catchall group is where you budget sheer splurges, from a movie night to new espadrille wedges.
Create a Special Savings Account for Taxes
When you’re self-employed as a sole proprietor or independent contractor, you’re required by U.S. law to file an annual return and pay estimated taxes quarterly, according to the Internal Revenue Service. “Set up a monthly contribution to a savings account earmarked for taxes so you're not caught off guard,” says Bera. If you have a boss who takes out taxes each paycheck when you’re in work mode, you can skip this part — though, of course, you still have to file an annual tax return.
Prioritize Your Splurges
When it comes to choosing what to spend your hard-earned dough on in your “everything else” category, “base it on your values,” says Hawlk. “Ask yourself what's important to you. I love what my friend and financial blogger Paula Pant says: ‘You can afford anything, but you can't afford everything.’ I live by that idea!”
Say you’re hankering to make a big purchase, like a new sofa or a laptop, in the near future. If you have enough extra money coming into your “everything else” category to cover these costs, then buy it — no questions asked, since you already parceled out money to the other areas of your life. But if it’s a month where that “everything else” portion isn’t making it, then try to skip as many splurges as you can. This way you can carry over the extra money into your next month’s cycle to make the purchase without dipping into savings.
Finally, just like you would be eyeing the next promotion and title change if you were working at a company, always plan on ways to earn more. “Sure, you should avoid lifestyle inflation and you need to understand the difference between what you need and things you just really want. But you don't have to live on ramen noodles. Get out there and look for new income streams,” says Hawlk.
Evaluate your client list, for example. Are you working with someone for a lower rate than you currently charge? If so, “Send them a polite email letting them know your rates have increased,” Hawlk advises.
You can even figure out ways to monetize other skills or hobbies. “There are lots of opportunities out there, and earning more is exponentially more powerful than cutting expenses,” she says. Your passions could out pay out.