4 Easy Steps to Budgeting with a Variable Income

If you are paid commission or have variable/intermittent income, you can probably understand the following scenario:

You make a killing one month and decide to finally purchase that big ticket item you’ve had your eye on for so long.  As you hand over your payment for said item, you can’t help but bask in the glory of being compensated appropriately for a job well done.  

Reality then hits with your next paycheck, reflecting that business this month didn’t go as well as the former.  You end up scraping for money until your next paycheck arrives and the cycle continues with highs, lows, discouragement and confusion.  

How is a person to properly plan for their spending with such erratic paychecks? How do you know when it’s appropriate to throw extra money into savings or your goals and, yes, even treat yourself beyond what you normally would?

I can relate to these frustrations.  It was almost 9 years ago when my husband, who was the sole provider at the time, started a career path that would compensate him with both a base and commission pay.  

With that, I’ve had a lot of practice budgeting with this kind of pay structure and have had the headache, (ehem, joy) of finding a way to manage his income so that the ebbs and flows of his paychecks didn’t seem so… ebb and flowy.  

I researched and implemented multiple ways to budget with his inconsistent income. In fact, many of you have probably heard of and even tried them as well. 

For the sake of brevity, though, I’m going to jump right into discussing one of my top favorite and most recommended methods and, ultimately, the method I implement with my family’s personal budget. 

Let me know in the comments below if you’re interested in me sharing some other great methods for budgeting with intermittent/variable income.

Enter what I like to call “The Income Protection Plan.” Here’s how it works…

Step One: Review your Past Income

Take a look at your paychecks over the last 6 months or whatever span of time you believe includes both high and low seasons in your line of work.  Now, go ahead and average out those paychecks.

Example: John is paid commission for his job in sales.  He observes that 6 months is a span of time that generally reflects a mixture of low sales/income months and high sales/income months.  

Accordingly, he chose to look back at 6 months of income to calculate his average.  His calculations looked something like this: 

• • January’s Income = $6,000
  • February’s Income = $8,000
  • March’s Income = $10,000
  • April’s Income = $5,500
  • May’s Income = $7,800
  • June’s Income = $9,400

• Most recent three months’ average income was:

•  ($6,000 + $8,000 + $10,000 + $5,500 + $7,800 + $9,400) / 6 = $7,783.33

Step Two: Budget the Average

As you can see, John’s paychecks ranged from $5,500 in April to $10,000 in March. Instead of budgeting based on his current month’s income which can be wildly different from month to month, John decided to budget based on the 6 month average of $7,800 (we’ll round it to make the math simple) for the month of June.  

But wait, you may have noticed that John got paid $9,400 in June but he’s only planning to use $7,800 that month?  What’s he to do with that extra $1,600? 

As tempting as it would be to spend that money on a shiny new toy or even use it to pay down debt, John knows that another $5,500 (or maybe even less) month is likely looming around the corner.  

He wants to be prepared for that likelihood so that he won’t feel the need to reactively dig into more debt. This forward thinking leads him to step three…

Step Three: Fund Income Protection Savings Account

Since John had an extra $1,600 leftover from his paycheck that he’s not planning on including in his budget for June, he’s going to go ahead and put that extra money into a separate savings account titled “Income Protection” and it’s going to hang out in that account until it has a job to do.

Step Four: Give Income Protection Money a Job

Now let’s fast forward to July. Let’s say John’s paycheck that month was $6,800.  He’s going to go ahead and repeat steps 1 and 2 as he creates his budget for that month.  This process will look something like this:

• February’s Income = $8,000
• March’s Income = $10,000
• April’s Income = $5,500
• May’s Income = $7,800
• June’s Income = $9,400
• July’s Income = $6,800
• Most recent three months’ average income was:
  • ($8,000 + $10,000 + $5,500 + $7,800 + $9,400 + $6,800) / 6 = $7916.67

Based on the most recent 6 month average income, John is going to budget $7900 (again, rounding to keep the math simple). 

Notice how, while his income varies greatly, his average income stays fairly consistent. 

Also, notice how he is going to be budgeting based on a number that is greater than what he actually made in the month of July.  What’s John to do?  

You guessed it.  He is going to transfer the difference of $1,100 ($7,900 avg – $6,800 paycheck = $1,100) from income protection and, just like that, he has the full $7,900 at his disposal to work with in July, leaving a balance of $500 in Income Protection.  

Potential Set-backs

Once you get in a rhythm and have used this method for a few months, you’ll find that budgeting off of a more consistent income helps you spend, save, and pay off debt with so much more intentionality and confidence.

There are, however, a few roadblocks that might come your way and, instead of letting them derail your progress, we’re going to make a plan for them!  Here are a few scenarios to prepare for.

First Month’s Paycheck is Lower than Your Average 

Your first month implementing the Income Protection plan might calculate a higher average than your paycheck with no money in income protection to pull from. 

If this is the case, I recommend budgeting off of that month’s paycheck and wait for the following month, in hopes that your pay is higher than the average so you can start stocking the extra money away. 

Income Protection Balance Won’t Cover This Month’s Budget

This is a similar setback to the previous one except, in this case, you’ve been working the plan for months but had an exceptionally low income month with a paycheck to average difference that Income Protection can’t fund. 

In this case, you might choose not to pull the full amount, leaving a buffer in Income Protection in case you need to pull a little money the next month as well.  

If you keep averaging out the most recent 6 month’s income, you’ll find that things even out eventually.  Worst case, you might observe that your paychecks are consistently lower than they used to be and you can do some problem solving to get them back up and/or adjust your cost of living.

Income Protection Balance Gets Too High

I bet you’re wondering how this could possibly be a problem.  If your Income Protection plan is consistently growing past a point that you’d most likely not need to use its full amount even if you had 6 consistent months of lower income, then you can comfortably assume two things:  

Thing One: Your income appears to consistently be going up.  Yay!

Thing Two: You may be putting money into Income Protection that’s just going to sit there until the end of time with nothing to do.  

Here at Craig Dacy Financial Coaching, we encourage our clients to max out the efficiency of their money, giving every dollar a job.  

If you find that your Income Protection Plan gets past a certain intentionally calculated threshold, you might decide to no longer put money into that fund until/unless it dips below that threshold.  

Instead, I recommend throwing that extra money toward debt or other savings goals or, if you’re debt free and have a fully funded emergency fund, then congratulations.  You have some extra blow money at your disposal.  Hooray!!

If this sounds interesting to you but you’d like an expert to walk you through the process, go ahead and book a call with one of our coaches.  We’re here to help and will be sure to guide you through setting up a system that will work for your unique situation.