The Determined Dollar

How to Budget for Unpredictable Income

Your income for the month ahead is unpredictable next to impossible to guess. There are some really good months, and there are some super tight months. The not-knowing is stressful.

You wonder if next month will be enough to cover the bills. You want to leverage the extra income when you make more, but you don’t know how to balance all your savings priorities. It’s frustrating to not be able to budget based on a steady paycheck.

If that describes you, then read on! By the end of this post, you’ll have a plan to smooth out your budget so that you CAN plan each month based on consistent amount, have money to fill in the gaps when a low paycheck month strikes, and save systematically for the future. Unpredictable income does not have to stop you from having an easy and effective budget!

Step 1: Start a Hill and Valley Fund

If the lowest month’s pay you’ve earned in the last year was not enough to cover your family’s basic needs (like food, medications, and school supplies in addition to paying the bills), then you need a hill and valley fund.

The hill and valley fund is to your budget as a water reservoir is to a California drought.

You know there will be months of financial “drought” so you need to fill that money reservoir.

Let’s say your baseline budget requires $4,000 a month.

Starting now, every time you bring home a paycheck that is more than $4,000, put all the extra into your hill and valley fund.

Set a goal to save three months of “drought” coverage, or more if you find that low months exceed three months of the year.

For instance, if you know that you’ll make no less than $2,000 a month then you need to fill a $2,000 gap for one low month, so your hill and valley fund goal would be $6,000.

($4,000 baseline budget – $2,000 gap = $2,000 needed x 3 months = $6,000)

Live on that baseline budget until your hill and valley fund is full.

One quick note on this fund: it’s not an emergency fund. Your emergency fund is totally separate. The emergency fund is still reserved for emergencies only, and your hill and valley fund is there to cover regular expenses so that your budget is smoothed out and paying the rent doesn’t become an emergency.

Step 2: Make a List of Savings Goals and Discretionary Spending

Now that you’re covered for low months, you can start saving for future expenses without risking the ability to meet basic obligations like rent and utilities.

Make a list of savings goals and discretionary spending. Examples include extra on debt, birthday presents, Christmas, travel, car repairs, restaurants, and kids’ extracurricular activities.

Order these categories from highest to lowest priority. Obviously things like car maintenance are more essential than eating out, but there is wiggle room depending on where you’re at in the baby steps and your lifestyle.

Then use this irregular income planning form to list out those saving and spending priorities.

Step 3: Use a Predictable Budget with Unpredictable Income

At this point, you’re set up to enjoy a consistent, predictable monthly budget.

In our example, we have a baseline budget of $4,000. Because you have a hill and valley fund, you can count on having at least $4,000 available to you every single month.

I recommend keeping your hill and valley fund in a savings account that’s connected to your checking account so that you can quickly transfer money when needed, but apart from other savings so that it stays organized and is less of a temptation to spend on anything besides its intended purpose.

Every month you can make a $4,000 monthly budget, and any extra in your paycheck funds your savings and discretionary spending. Since you have already planned for the extra income according to priority, you don’t have to worry about making emotional or rash decisions about where that money should go.

Let’s say you have $1,500 worth of savings and spending categories written in your irregular income planning worksheet, and your paycheck is $5,000. That gives you $1,000 to fund these extra categories.

Allocating Extra Money

The reason we order by priority is that the last $500 of categories won’t get funded. So if you have car maintenance and kids activities at the top, those will get fully funded, and if travel is last, you won’t be adding anything to your travel fund for the month.

On the other hand, when the paycheck is $6,000, you have an extra $500 on top of funding your irregular expenses. When that happens, simply decide which is your biggest priority at the moment and allocate it accordingly.

Any time your hill and valley fund gets below two months of “drought coverage,” pause your irregular income funding, and refill the hill and valley fund. Again, if you tend to have more than three months a year with below baseline paychecks, then you might want to have a larger hill and valley fund and refill it sooner.

Now you can relax knowing that you can create a predictable monthly budget for unpredictable income, have what you need to get you through low paycheck months, and have a systematic plan to save and accomplish your financial goals.