Unpredictable income requires planning

Financial Planning for When Income is Unpredictable

By Peter Mastrantuono

Running your own business is hard work, but there is a unique sense of satisfaction that comes with building your own success. For many business owners, freelancers, artisans and artists, self-employment also means erratic and unpredictable income, which can be a challenge when it comes to managing personal finances.

To square the circle of irregular income flows amid very predictable living expenses, here are five steps that can put your family finances on firmer footing.

  • Build an Emergency Fund: The traditional advice is that an emergency fund should equal 3-6 months of living expenses. For individuals with uncertain income flows, however, a more appropriate number may be 9-12 months.

A larger emergency fund may be needed for two reasons: 1) Slow business cycles can last longer than a simple job search and 2) your emergency fund may have to cover not only personal expenses, but also business-related expenses that continue even in the absence of revenues.

  • Create a Two-Tier Cash Flow System: The first step in creating a two-tier framework for income is to develop a baseline budget comprised of monthly essential spending, e.g., food, utilities, rent, etc. Open a checking account for these expenses and direct income into this account until the amount of monthly basic expenses, e.g., $3,000, is reached.

Any and all income over the essential living expenses can be directed into a second account, from which discretionary expenses (e.g., vacation) can be paid or long-term goals, such as retirement, can be funded.

One of the biggest mistakes many self-employed individuals make is overspending when cash flows are high. This dual account structure will provide the discipline to both stay within a budget and keep long-term financial objectives in sight at all times.

  • Insure Against Financial Risks: Nothing undermines an intelligent savings and investment plan more than unexpected life events, like an extended illness or disability. Consequently, adequate health, disability and life insurance are indispensable to maintaining financial health. The loss of income due to a disability or incurring large medical bills can upend your family’s financial stability—a scenario readily avoidable with proper insurance coverage.
  • Plan for Taxes: Since you pay your federal and state income taxes periodically, usually quarterly, it’s easy to underpay the taxes you owe or let these payments slide altogether. However, income tax bills will come due. The failure to pay throughout the course of the year can result in a large tax bill (including underpayment penalties) that can strain your budget unnecessarily.
  • Create a Plan: While income may be unpredictable, you have the same financial dreams of any American—build a secure retirement, fund a child’s college education, travel far and wide. Achieving your long-term objectives requires a good financial plan that outlines a pathway to success. Without one, your dreams are little more than wishful thinking.

No one said that self-employment would be an easy road to travel, but teaming up with a financial advisor experienced with working with entrepreneurs and business owners like you may help to make the journey smoother.

Peter Mastrantuono is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.

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