3 Ways to Weather Variable Income

Though freelancers, independent contractors and entrepreneurs don’t often have regular income, this doesn’t have to cost you. Staying a few steps ahead of all that you can’t predict or control can help you stress less—even when you don’t know when your next paycheck is coming in. Here’s how to make variable income work for you.

1. Keep your business out of your personal life

Separating business and personal finances makes your income clear at tax time. And it helps you see what you have to spend.

• Separate your personal and business checking and savings. Use the business account for business payments and deposits only, and your business savings account to save for tax time.

• Get a business credit card to establish your business credit, simplify accounting, and bridge any cash flow gaps. Use this card for legitimate business expenses only. You can deduct any interest expenses for this card from your taxes—a small perk if you carry a balance.

• Pay yourself a salary every month. Write yourself a check from your business checking account and deposit it in your personal checking account. This formality helps prevent impulsive draws and makes it easy to distinguish personal from business earnings.

2. Know your money habits—at work and at home.

Getting clear about what you’re spending and saving—and why—might feel like a hassle at first. But it gives you more freedom in the end. Two simple systems can take you there.

• Map your spending. Tracking your personal cash flow every month can help you better understand what’s happening with your money. A free service like Mint, or a paid program like Quicken makes it easy to see the full picture of your personal income, expenses, and savings.
  With this knowledge comes choice. Once you realize you’re spending $150/month for lattes, you may decide this expense is exactly in line with your values. Or you may prefer to use that money to pay down debt or to fund a weekly date night. Getting clarity around your spending empowers you to choose.

• Set a budget. Your budget is your spending and savings plan. You can structure yours to make the most of your variable income:

  • Base your monthly income projections on last year’s lowest-paid month.

  • Divide your monthly expenses into two categories: baseline (necessities such as housing, utilities, groceries, transportation), and flexible (discretionary expenses such as entertainment, beauty, vacation).

  When you get paid, first pay your baseline expenses. Then use the income that remains to pay down debt, save, or make discretionary purchases.

• Give your budget regular check-ups. Once or twice a year, re-evaluate your budget categories and expenses based on your actual spending patterns. If you see that you typically spend $50 more on groceries than you’ve budgeted for, you may want to increase your budget for this line item or learn to shop differently.

The more you know and the more you plan, the more your spending will reflect what you truly value.

3. Save smart

Flush times can help you fund lean times, if you save strategically. Here’s a way to stay in the black, whether you earned $20K or $2K this month.

• Pay down debt. Credit card debt is likely costing you more in interest than you’d gain by saving. That’s why your first priority when you have extra income should be eliminating this type of debt. Once the debt is cleared, you can start funding your savings. (Some experts advise saving alongside debt reduction. Do your research on what makes sense for you.)

• Bridge the gap. In the months when your income is more than you need for your baseline expenses, deposit any excess in a savings account. Then, in the months when your income is less than you need for your baseline expenses, you can draw from this savings to cover the difference.

  How do you know how much to save? Set your target based on your biggest cash flow gap last year. Let’s say your income was $1,000, your baseline expenses are $6,000, and you needed $5,000 to cover the gap. Expect to pay $5,000 for all future variable months, and you’ll be prepared for your own worst-case scenario. Depending on your risk tolerance, you might want to create a three-to-nine-month buffer (that’s $15K to $45K using this example).

• Stay in the black. Once your variable income account is fully funded, you can create an additional level of protection. Instead of taking a hit on your credit card when unexpected expenses arise, prepare in advance by creating a reserve. Use this savings account to stay ahead of life’s inevitable surprises with the funds you’ll need to cover a new roof, braces, medical and veterinary emergencies, or car repair.

Experience breeds confidence. When you can’t count on consistent earnings, you’ll learn to count on yourself to spend and save in ways that make the most of your money. So self-employment feels like less of a gamble. And no matter how variable your income, you’ll develop your own sense of balance.