By Lyn Dippel
November/December 2016
Many of us have unpredictable or inconsistent incomes. Unfortunately, the bills come whether we have been paid yet or not. If we have not planned carefully, when a big expense occurs we may get caught short. And two other pitfalls may trip us up if we are self-employed. First, there is typically no tax or FICA withholding on self-employment income, so often a portion of the money we have in hand is not technically ours. If we aren’t careful we can get caught shorthanded come tax time and end up owing penalties on top of the tax bill. In addition, those who are self-employed are required to pay both the employer and employee part of FICA (Social Security and Medicare) on our wages and Schedule C (self-employment) income. Typically, employees pay 1.45% of their wages or Schedule C income to Medicare and 6.2% to Social Security on up to $118,500 in income. Self-employed individuals pay double this since they pay both the employer and employee portion.
WHAT FOLLOWS ARE STEPS TO KEEP THINGS HUMMING.
To begin with, set up three separate bank accounts. The first should be your business account. This is the account into which all your business income should be deposited and from which all your business expenses should be paid. Then set up a personal checking account. This is the account from which all your personal expenses should be paid. Finally, set up a personal savings account. This will be the place to accumulate funds for quarterly taxes and large annual expenses.
To smooth out the monthly finances, estimate your average monthly income by taking last year’s net income (your business income minus your business expenses, your taxes and FICA) and then dividing by 12. Next, figure out your basic personal monthly and annual expenses. Some helpful online tools are listed below to help with this. You can also use applications such as quicken or Mint.com to track expenses.
Now pay yourself two checks each month from your business income. The first should be enough to cover your basic personal monthly expenses. Deposit this check into your personal checking account. The second check is for income tax, FICA and one twelfth of your estimated annual expenses, and should be deposited in your personal savings account. When it is time to pay estimated taxes or a big bill, the corresponding amount can be transferred to your personal checking to pay the bill. Use the same bank for all three accounts so you can simply transfer the funds electronically each month. Any funds left over in the business account should remain there for the next month when income might be lower. Ideally, any excess built up in this account can be used to establish a reserve that you can eventually invest for retirement or other long-term goals.
As you become more comfortable with your annual income estimates, you can build more discretionary items into your monthly “paycheck” amount and add an additional amount to be invested each month from your business income.
For more resources check out the sites below or for an expense worksheet you can email me at [email protected].
- thesimpledollar.com/how-to-budget-with-an-irregular-income
- forbes.com/sites/learnvest/2013/05/24/ irregular-income-heres-how-to-budget/2/#415028d54fa0.
Lyn Dippel, JD, CFP®, president of FAI Wealth Management, provides financial planning and investment management for transitions such as retirement, career changes, sale of a business, relocation and inheritance.
