Laura answers a listener's question about how to manage money and create a budget when you have an irregular income.
Laura answers a listener's question about how to manage money and create a budget when you have an irregular income.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Laura answers a listener's question about how to manage money and create a budget when you have an irregular income.
Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Theresa J., who says:
"Thanks so much for all your great advice. I listen every week, and although some things don't apply to me, I inevitably learn something new. I'm a self-employed Notary Public and have owned my business since 2016.
The last three months of 2024 were slow, and I used all my savings to make ends meet, which scares me. I want to create a budget but never know what I will earn until the month ends. Plus, my utilities and business expenses vary and are going up.
I'm overspending and not saving, but don't know where to start. How do I budget when my income is irregular?"
Thanks for your question, Theresa! There are many people with jobs or businesses that earn an unpredictable income. You might be self-employed, like Theresa, with an unknown number of monthly clients or a salesperson paid solely on commission. That makes budgeting more challenging, but I'll give you strategies to better manage your cash flow and feel more in control of your money.
Thanks for downloading episode 899 of the Money Girl podcast! I'm Laura Adams, an award-winning author, money speaker, on-camera spokesperson, and founder of The Money Stack, a free Substack newsletter.
You can learn more and connect with me at LauraDAdams.com. That's also where you can email your money question and sign up for The Money Stack, which gives subscribers a terrific Money Success Toolkit. You can also record a brief question or comment on our voicemail line at 302-364-0308.
6 steps to budget with irregular income
Here are six steps to create a budget even if you have irregular monthly income and
expenses.
1. Know your financial goals.
Creating a budget is a perfect time to define or redefine your financial goals. While a budget must cover your expenses, it should also be based on what you realistically want to achieve with your money.
For instance, do you want to buy a home, retire early, take an epic vacation, or put your kids through college? They aren't likely to happen if you don't regularly earmark money for your short- and long-term goals.
An excellent way to get started is by downloading my free Financial Planning Workbook (PDF) and setting aside at least 30 minutes to complete it. It's a free gift when you subscribe to The Money Stack, my free Substack newsletter.
Review the workbook together if you have a spouse or partner who shares your financial life or goals. It will prompt you to ask important questions and answer them as thoughtfully as possible so you can set the right financial goals.
If you're not sure what financial goals to set, consider the following:
Adding timelines for achieving each financial goal helps guide your budget. For instance, if you want to build $1,000 in emergency savings within the next twelve months, budget approximately $85 per month. If you want to maximize an IRA by contributing the 2025 limit of $7,000, that's about $580 per month.
RELATED: Is it better to have a traditional or Roth IRA?
2. Determine your average living expenses.
After considering your financial goals, the second step to budgeting irregular income and expenses is determining your average living expenses. These are necessary expenses that you likely can't reduce or eliminate, like housing, food, insurance, transportation, and healthcare.
You'll need to gather the past three months of your financial transactions or more, if possible. You might enter your data in a computer spreadsheet or sync your financial accounts to a bookkeeping or budgeting program like Quicken or YNAB.
For living expenses that vary each month, such as groceries, utility bills, and gas, you must estimate a monthly average. For instance, if your utility bills over the past three months were $125, $150, and $175, you can add them up and divide by three for an estimated average of $150 a month.
If you have expenses paid quarterly or annually, like auto or life insurance, break them down into monthly amounts. For instance, if you spend $500 for auto insurance twice a year, divide $1,000 by twelve months for a monthly estimate of $85.
As you review your typical monthly spending, see where you may be overspending and could cut back. Constantly reconsider what's necessary and which expenses you can shop around to potentially reduce.
READ ALSO: 10 ways to save money on car insurance
3. Add your financial goals.
Once you know your average monthly living expenses, add your financial goals to your budget. While they aren't necessary for short-term survival, they are critical for your long-term financial security and happiness.
If you have irregular income, allocating monthly amounts for goals like building an emergency fund and investing for retirement is even more critical. I challenge you to consider them "expenses" you owe yourself monthly. Otherwise, it gets easy to spend extra money and never get ahead financially.
Don’t forget that you must pay quarterly income taxes if you have business or self-employment income, and should include it in your baseline budget. If you're unsure how much you'll earn, you can estimate taxes based on what you earned last year.
Some financial programs estimate your potential tax liability and break it down into quarterly payments. However, I always recommend getting guidance from a certified tax professional.
But a good rule of thumb is to set aside 25% of your self-employment income for taxes--unless you're a high earner and may need to pay more.
4. Identify your discretionary expenses.
Once you've identified your living or baseline expenses, including your financial goals, everything else in your budget is discretionary. If you're struggling to save money or pay off credit cards, you likely have discretionary expenses that should be reduced or eliminated.
So, take a hard look at temporarily or permanently cutting any discretionary expenses you can live without. That can be the ticket to boosting your savings and improving your finances.
While you can also cut certain living expenses, like housing and vehicles, they're typically more difficult to reduce than discretionary ones.
5. Create an ultra-conservative budget.
Now that you've thoroughly reviewed your living and discretionary expenses, create an ultra-conservative budget based on an average of your lowest months of income. Use a reasonable period for your situation, such as last year.
For example, if your lowest months of income were $3,000, $4,000, and $5,000, add them up and divide by three months for an average of $4,000. If your monthly expenses exceed that amount, it's time to radically cut your living expenses, discretionary expenses, or both. It's your job to ensure you create a solid plan never to spend more than your low-end average income.
Budgeting with the low end of an irregular income doesn't guarantee you won't have some challenging months. But it does reduce the likelihood that you'll come up short. And when you earn more than your low average, you'll have a financial cushion, which I'll explain how to manage next.
6. Use a holding account.
The secret weapon for sticking to a budget with irregular income is using a holding account. It’s a secondary checking account you might open with your existing financial institution. That's where your income should go until you transfer it to another account, such as your primary checking or high-interest savings.
To smooth out your finances when you have irregular income, you must transfer a set amount from your holding account to cover your expenses. I recommend transferring no more than your low-end average income into your primary checking account.
For instance, you could transfer it all on the first of the month or half on the first and fifteenth. Then, you can pay your expenses, including funding your financial goals, according to your desired budget.
Using my previous income example, let's say you make $5,000 and put it into your holding account. You would only transfer $4,000, your average low-end income, into your checking. The leftover $1,000 would remain in your holding account as a cushion that you only tap if your income dips below $4,000.
Make a goal to build up at least two months of your high-end average income as a reserve. For instance, if the average of your three highest-earning months from the previous year is $7,000, slowly build up your holding account to $14,000.
This strategy will allow you to pay yourself a consistent monthly amount instead of feeling like you're on a rollercoaster of irregular income. Your higher-income months can balance out the lower-income months, allowing you to build a safety surplus in your holding account over time.
Adjusting your necessary and discretionary spending for an average lower-income month can be challenging and take time. Be patient with the process and experiment with different methods, apps, and budgeting programs until you find a system that keeps you on track.
If you struggle to increase the balance in your holding account, consider getting a second job or doing seasonal work to get ahead financially. Any sacrifices you make now will be worth it when you take control of your cash flow, build wealth, and achieve your financial goals.
Once you have emergency savings plus a surplus in your holding account, you'll have a nice financial cushion to stay safe if you have several low or no-income months.
Before we go, here's a quick reminder to subscribe to The Money Stack, my Substack newsletter, when you visit LauraDAdams.com. It's filled with money tips, tools, news, challenges, and things I enjoy! You can subscribe for free or become a paid member with access to live educational events.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.