For years, Russell Wild, 61, was one of millions of Americans who didn’t know from where or when his next check was coming. The former freelance journalist says he’s very familiar with living with volatile income, some months raking in far more than he needed and other months scraping by while waiting for the next check to arrive.
“Both the income side is volatile, and the expense side, especially where health care is concerned, because freelancers don’t have corporate coverage,” says Wild.
Nearly one-third (34%) of Americans said they faced large swings in income from 2014 to 2015, according to a recent analysis by PEW Charitable Trusts. The research group defines a “volatile” income change to be an increase or decrease of at least 25%. Among households whose earnings declined, the median loss was 49%.
In 2004, Wild dropped his freelance writing career for something more stable. He’s now a registered financial adviser and author based in Philadelphia, Pa. He says he watched fellow freelancers “go into panic when they saw that there was little chance of covering the next month’s rent, or the latest doctor’s bill.”
Year over year fluctuations in household income occur for a number of reasons. A worker might get an annual bonus or promotion. On the flip side, a worker could experience a sudden illness or job loss. Those in contract or freelance occupations are especially vulnerable to income volatility. Researchers also found Hispanic, less-educated, and low-income American households are most susceptible to income volatility.
Households experiencing inconsistent or irregular income may be able to leverage the following tips to better manage financially and get prepared in case of a financial emergency.
- Base your budget on your lowest grossing month
Your household’s income might be volatile, but your goal should be to make sure your lifestyle is as predictable as possible. You can add some stability to your life by establishing a budget.
“Try to live within a fixed income — the lowest point of your fluctuating annual or monthly household income,” says Arlington,Va.-based financial planner Hui-chin Chen. Those with volatile income should also try to limit debt and unnecessary spending.
Monitor your household’s cash flow carefully to see what you’re spending money on, then cut out the unnecessary expenses until you are left with your fixed costs, such as housing or monthly bills.
“Without being aware of what you’re spending and where, you can overspend your sometimes low income without realizing it, or treat yourself to more than you should when there’s a big month,” says Stephen Fletcher, a financial planner at BlueSky Wealth Advisors in New Bern, N.C.
Keeping record of your spending might be tough to do at first, but budgeting apps like EveryDollar, Level Money, and Mint can help you keep an eye on yourself or your household.
“Volatile incomes require discipline, otherwise you can end up feeling like you are living paycheck to paycheck,” says Fletcher.
- Set your lifestyle now
Once you’ve got your budget together, don’t fall prey to lifestyle inflation when you have a couple of months of steady work or receive a large influx of cash. Try to develop regular spending and saving patterns.
“If you know what you need to keep the lights on and you know what you need to pay yourself (save), it’s much easier to plan for influxes of cash that need to be set aside,” says Chicago-based financial planner Nick Cosky. He says households can get started by setting monthly and annual spending and savings goals.
Try to make as many monthly and annual expenses as possible predictable and planned. For example, if you know your expenses totaled about $5,000 last month, then you should plan to spend no more than $5,000 this month and the following month.
“Live below your means, especially until you have achieved sufficient cash reserves and savings,” says Anne C. Chernish, president and managing member of Anchor Capital Management in Ithaca, N.Y.
Once you’ve maintained a certain level of monthly cash flow and your emergency stash is all set, you can adjust your quality of life accordingly. If you can afford to, Patrick Amey, a financial planner at KHC Wealth Management in Overland Park, Kan., suggests those who experience regular volatility keep one to two years of living expenses available — just in case you need to maintain your lifestyle without a paycheck for a while.
- Anticipate large expenditures
If you are aware of a large expense coming up — maybe your car needs repair or you’re aware of necessary medical services or even paying your taxes each year — you should plan to save as much as you can before the bill comes.
Create a separate savings account and allocate funds toward it periodically for the upcoming expense. Make sure your savings goal considers all of associated costs, so you won’t get caught off guard.
“With purchases like cars, homes, and other large items, these types of purchases require insurance, property taxes, etc., so buying when you have just enough cash to make the purchase can have serious and crippling long-term effects,” says Fletcher.
- Always plan ahead for taxes
If your income varies because you’re a contractor or work for yourself, you’ll need to budget for tax withholding. You can plan ahead and pay your taxes quarterly. You’ll get the payment out of the way, plus you won't feel it as much as you would if you pay when you file your taxes.
Unfortunately, if you experience income volatility, you might pay a different amount in taxes if you have a particularly good — or bad — year and enter a different tax bracket.
“Higher taxes follow good earnings years and, if one has insufficient reserves for tax, can deliver a double whammy. Just as the income turns down, the tax from the previous year is due,” says Chernish.
For that reason, Cosky recommends you get 6 to 12 months ahead of the tax liability and keep your CPA or tax preparer in the loop so they can help you plan tax withholding.
If you’re doing your taxes on your own, you can use this IRS form to estimate your taxes owed each quarter.
- Have multiple income streams
When your main income stream is inconsistent, it might help to pick up a second job to help cover expenses during economic downswings or simply to ensure your expenses will be covered.
As an added benefit, you might also feel more financially stable, as you could possibly put more money into your savings.
Wild, a former president of the American Society of Journalists and Authors, says for most freelancers that might mean accepting a corporate contract and working on your more creative projects in-between the corporate job’s deadlines.
“When I was writing full time, before I started financial planning, I always had a steady gig. I was for years a regular contributor to various magazines, and later I had book contracts with decent advances,” says Wild.
- Save at least a year’s worth of expenses
Lynn Dunston, Senior Wealth Manager at Dunston Financial Group in Denver, Colo., suggests those with volatile income have enough money saved in an emergency account to cover a year’s worth of expenses, instead of the usual 3- to 6-month savings recommendation for those with stable income.
“It is critical that if there is a down month, they are not having to accumulate credit card debt or take out loans in order to continue their standard of living,” says Fletcher.
- Make sure your money is working for you
After you have your emergency savings funded, it might not make as much sense to continue to put ALL of your extra savings there. Since interest rates on savings accounts currently lag behind inflation, your money would actually lose value in the typical savings account today.
You can stash “near cash” in higher-yield savings options like short-term bonds or CDs. Mark R. Morley, president of Warburton Capital Management in Tulsa, Okla., tells his clients to create a “currency escrow” or a safe bond portfolio that can be liquidated as needed for currency needs. The escrow ideally holds at least one year of expenses in short-term investment bonds. Morley says it can be used to supplement income or added to when income is high.
Fletcher says to avoid tying up all of your cash savings in retirement accounts like a 401(k) or IRA to avoid penalty charges in case you need to withdraw the funds early. Instead, he suggests you invest excess funds in a brokerage account, since you can take money out of that with little or no tax implications.