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Can I Really Plan With a Variable Income?


 

If your income includes commissions or bonuses, you have a great opportunity to be able to make strides in your finances that others with more predictable incomes can’t make. However, if you don’t plan for it, extra income can quickly lead to lifestyle inflation and leave you wondering where all that money went. On the flip side, less variable income than you were planning for can leave you scrambling to fill in the gap.

When planning for variable income, there are 3 types of situations with their own plusses and minuses. Below, I describe them based on the % of your annual income the variability comprises, and the frequency of the income, and give you some ideas to make your financial plan a success.

Situation #1 – Bonus time

If you’re in this situation, you typically receive an annual bonus that can be 5-20% of your income, or a healthy tax refund that you treat like a bonus (it really isn’t, but that’s a subject for another post). This is great because you should be budgeting based on your normal income, for your normal expenses, and you can use this chunk of money to make big strides in reaching your financial goals.

  • Emergency Fund – if you don’t have an emergency fund, now is a great time to stick this influx of cash into a high-yield online savings account that will give you peace of mind when handling unexpected expenses that will come up. Three to six months of expenses saved is the normal recommendation here, but that could vary based on your situation.
  • Large Purchase Downpayment – if you plan to buy a car or a house, put this money toward that if you already have an emergency fund. You will get better rates on car financing and mortgages the more you put down. It will make your monthly payments smaller as well which improves your cash flow going forward.
  • Debt Repayment – take your highest interest debt and pay it off. You will pay less in interest over time, simplify your finances, potentially lower your ongoing payments, and give yourself momentum for continuing to pay down debt in the future.
  • Do Something Fun – Notice I didn’t say “Buy something you want”. Experiences have been shown to increase happiness in the long term more than material purchases. Using your money as a tool to create memories and good times with friends or family is a great investment.
  • Change Your Life – Last year I used my bonus to start my business. Think big.

Situation #2 – Quarterly commissions/bonuses

In this case, you may depend on these quarterly payments to cover your normal expenses, because it’s likely to be 25-50% of your total annual income (or more). It would be great if you could live on your stable income only, so consider if you can adjust your lifestyle. Then consider using your quarterly income to address one of the suggestions above or below. If you can’t or won’t adjust your lifestyle, then skip to #3.

  • Retirement Savings – If you participate in a company 401(k), check to see if your contribution is calculated on regular salary only, or also on commissions/bonuses. You may even be able to contribute just from commissions/bonuses, leaving your stable income for expenses. If you’ve maxed out your company pre-tax plan, an after-tax investment account may be a good option.
  • Education Funding – If you have children, this is a great way to find income to fund their education. Think about how much you can contribute without going broke.
  • Another Big Goal – If you’re thinking about switching careers, starting a business, investing in real estate, or traveling the world, quarterly income is a good way to save for these goals because the money can add up quickly.

Situation #3 – Ongoing commissions or income variability

This is the toughest situation to plan for and budgeting is crucial. Maybe you receive commissions on weekly or monthly sales. Maybe you own a business or do freelance work. The variable piece of your income could be greater than 50% of your total income, all the way up to 100%.

Although the advice to “live on the stable portion of your income” is great, this just doesn’t work for you. You need a budgeting plan that takes the stress out of planning for monthly expenses, and also allows you to meet your future financial goals.

  • Scrutinize and track your expenses – it’s critical to know exactly how much you are spending so you know how much you need to make each month to cover expenses. You will need to separate your expenses into needs and wants. Typical needs are mortgage, rent, car payments, health insurance, utilities, you get the picture. Also consider savings and retirement contributions to be needs, because paying yourself first is the best way to long term financial success. Think about what you could live without if you had to.
  • Save money into a “refill” bucket – in months where you make more than your expenses, set aside money into a refill bucket that can be used to supplement lean months. This is different than your emergency fund. You should aim to have about one month’s of expenses saved in your refill bucket.
  • Live on last month’s income – if you have a lean month, you will have taken some money from your refill bucket. The next month it’s critical to pare down your “wants” expenses so that the refill bucket doesn’t run dry. Try and match your expenses to what you made last month.
  • Watch for lifestyle inflation – if you consistently are having good months, keep an eye out that “wants” don’t become “needs”. Think carefully before buying a bigger house or a newer car that can leave you in the hole if the lean months return. 

 

I hope these tips are helpful and give you the confidence that you can plan even with variable income. As always, I encourage you to reach out if you need to put a plan together, and want someone to keep you accountable going forward.