Budgeting for Irregular Incomes: A Step-by-Step Plan

It’s been said that we are now living in a “freelance economy,” in which many people generate the entirety of their incomes as independent contractors, and others supplement their 9-to-5s with a freelance gig or two. And by at least one estimate, 40% of America’s workforce will be freelancers by the year 2020.

That’s great for folks who love the freedom to work on their own schedules and the flexibility to work for multiple employers, but as income levels or pay dates from contract work can vary from month to month, establishing—and sticking to—a budget can be incredibly difficult.

To help, we’ve talked with top personal finance experts and developed a step-by-step budgeting plan for freelance and contract professionals.

1. Determine expected cash flow.

“For people with a salary, it’s easy to look month-to-month [to determine cash flow patterns], but with people on a variable income, you have to look at a longer cycle—usually year-to-year,” says Sean McComber, a Certified Financial Planner with Frederick, Maryland-based Key Financial Group. This process helps individuals recognize how much they really have to spend each month, as well as where lean periods tend to fall.

For new freelancers who don’t have a salary history with which to refer, Kevin Gallegos, Vice President of Phoenix Operations for the Freedom Financial Network, suggests plugging in an estimated income range based on known projects, contracts, etc. “If someone has absolutely no idea where any income will come from at the beginning of that month, they’ll have to plug in a number that matches their expense outlay,” Gallegos adds. “That ‘income’ would have to come from their savings.”

2. List expenses in order of priority.

Aaron Britz, financial planner and President/CEO of Legacy Wealth Management, is adamant about placing a priority on expenses as individuals begin examining their monthly payouts. He recommends a letter (A, B, C) and number (1, 2, 3) system, in which all A-items are vitals expenses that must be paid, B-items are important and should be paid, while C-items are someday items that could be paid.

“With the prioritized list of expenses in place, you now know what is paid first, second and so on,” says Britz. “If you get a $2,000 check this month, you would spend this first towards A-1, then A-2, etc. Once the $2,000 is gone, no more spending is done, no matter what remains on the unpaid list. That is why the ‘must-pays’ are on the top of the list.”

3. Cut back, and create a buffer.

After discovering lean income periods in Step 1 (as well as which expenses must be paid each month in step 2), freelancers typically have two ways to address any periodic reductions in funds:

First, says McComber, freelancers need to be intentional with their spending during high-earning periods. “What we find is that people will live on the money they have, [and] if they get a big sale and a big commission, they splurge on things they want or catch up on things that are past due, and next thing you know—it’s gone,” McComber explains. “So, after we’ve identified the tendency to spend everything, we have to reign it in by living a bit leaner. The objective isn’t to tell people to lessen their lifestyle, but to make meaningful and intentional lifestyle changes.”

After reducing expenses as much as possible, independent professionals then need to focus on creating a cash reserve (in a checking account) that holds at least a few months’ worth of living expenses. “When your cash flow is inconsistent, you want to build in a buffer so that you can remain scrappy and nimble to quickly 
adjust when income conditions change,” says Elle Kaplan, financial advisor and CEO/founding partner of Lexion Capital Management.

4. Pay off debt, and build a full emergency fund.

Once a smaller cash buffer is established, it’s time for freelancers to work toward building a full emergency fund with 6-12 months’ worth of living expenses to account for any major unforeseen changes, like a severe illness that prohibits work, or the loss of a major client. This is best done by paying yourself first, says McComber, who suggests that individuals “take money from earnings and pay it into [a] savings account, just like any other bill.”

If debt is an issue, McComber recommends individuals split the amount that they are depositing into savings on a monthly basis and dedicate a portion of it to debt reduction. Since minimum payments should be addressed with the rest of the monthly bills in step 2, this additional money will be added on top of existing debt payments.

“As an example, we would take $250 of [someone’s] available resources and add it to the minimum payment on one [credit] card, with the other $250 going to savings each month,” explains McComber. “That would accelerate the payoff of one card, and when that one is paid off, we would take that $250—plus the minimum payment from Card 1—and add it to Card 2. Then, Card 3 gets paid off with $250 plus minimum payments from Cards 1&2. The cash flow stays the same throughout, but each successive card is paid off even faster.”

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