A reader on the Mint.com Facebook page asked:
Any tips for money management with irregular income, for individuals in occupations who typically have commission income, bonus income, etc.?
Reader, you are speaking my language. As a freelance writer, I don’t receive commission or bonus income (I’ve always wanted a Christmas bonus, but I don’t see it happening), but irregular income? You bet.
Let’s distinguish between two different scenarios: the employee who receives occasional bonuses and commissions on top of a salary, and the self-employed person whose income has stomach-churning variation from month to month.
If you make a salary with bonuses and commissions, your best move is to live off the salary and save the rest. This presumes, of course, that the salary is more than subsistence-level; I’m not recommending that a waiter live off sub-minimum wage pay and save their tips.
The financial benefits of saving your bonus are obvious, but there’s also a psychological benefit: as long as you don’t spend more than your base salary, you can be confident that your lifestyle is sustainable, without having to worry about cutting costs if you get a smaller-than-usual commission check.
Plus, you get the satisfaction of money in the bank. To me, these twin wins easily outweigh the short-term pleasure of spending your bonus money, even on something with a retina display.
If your salary is meager and the bonus income is really a part of your pay, doled out unpredictably, read on.
Live freelance or die.
A salaried employee receives regular pay, tax withholding, and probably access to a 401(k). The self-employed get none of the above. (And let’s not even talk about health insurance.)
So we have to build these financial goodies ourselves, with the same DIY ethic we bring to the goods or services we sell. Here’s how. Every time you receive a paycheck, split the money into three separate accounts: one for spending, one for taxes, and one for retirement. (The tax account should be a regular bank account; the retirement account should be a self-employed retirement plan like a SEP IRA or individual 401(k).)
This avoids the common freelancer plague of forgetting to set aside money for taxes, an excuse the IRS finds distinctly unconvincing, and the other plague of “forgetting” to save for retirement.
In The Money Book for Freelancers, Part-Timers, and the Self-Employed, authors Joe D’Agnese and Denise Kiernan call these three accounts (spending, tax, retirement) the Holy Trinity. Neglect them and you’ll find yourself in freelancer hell.
Now, what about the money left in the spending account? Pay it to yourself as a salary—weekly, biweekly, or monthly, whatever you prefer. Be conservative about how much you pay yourself; if you’ve just had a profitable month, don’t assume you’ll do just as well every month. Look back over the past year or two, calculate an average, and subtract a bit for unanticipated lean months.
Pay yourself too much, and you might have to dip into emergency reserves, or worse. If you underpay yourself and your spending account becomes overgrown with languishing earnings, however, I can think of worse problems.
Mo’ money… you know the rest.
Irregular infusions of cash tend to overwhelm the responsible part of our brains. It’s hard not to feel rich when you get a larger-than-average check, even though our inner bean-counter is saying, “That money is supposed to last three months.”
People who manage to spend and save responsibly despite irregular income tend to use a system like the ones I described above, because it takes the willpower out of the equation. Instead of having to decide what to do with each $100 that comes in (save it? spend it? let’s spend it!), you’re following a set of rules.
I know a lot of people are resistant to any system that forces them to admit that, by analogy, if you left them in a room full of cookies, they would eat all the cookies. Sure, the truth hurts. Since the alternative is financial misery, however, I swallowed my pride (and probably a few cookies) and set up a system to keep me out of trouble.
Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.