How to budget when your income is irregular

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Budgeting is already a challenge, but what do you do when your income is irregular? And by irregular, I mean that it’s either unpredictable or it comes in on an irregular schedule.

It’s a tricky proposition, because a budget is basically a means to spread your yearly income evenly across the board, allotting certain amounts of it to pay for certain things. So, if your pay is irregular, it gets hard to make sure the money’s where it should be when the bills are due.

Well, this is our reality; my husband has a regular income, but he also has an irregular income as a volunteer firefighter. Don’t let the name fool you, he does get paid for it, but only twice a year. And the amount fluctuates depending on the number of pages he received in the 6 month period he’s being paid for. I also have some irregular income in the form of coaching fees and freelance writing, both of which are hard to predict.

So, how do I handle all this uncertainty? With math, of course! Those of you who regularly read my articles know by now that in my world, math solves everything.

I simply make my budget for the whole year, using reasonable and conservative estimates for the uncertain income amounts. Using last years’ numbers usually helps me to guess how much fire pay will come in this year, for example. I calculate all our expenses for the year, again using last years’ numbers as a starting point. I roll all the predictable and regular bill payments into one category called “already spent”.

I account for all the uncertainty by calculating what percentage of the total income is being spent in each category. Then, as I track the money coming in, only that percentage of the pay that came in is allotted to each given category as being “available” to spend.

You will very likely have some over-spending in some of the categories, but you can manage general over-spending by simultaneously watching the balance of the total that’s come in minus the total that’s been spent.

Let me demonstrate using an example from my budget:

I’ve budgeted the entire year’s worth of groceries into bi-weekly chunks, but in the six months preceding the fire pay being paid, we will very likely start to run a deficit in this category. To manage this, I watch the total balance and make sure it never goes in the red. So, I know I’ve over-spent on groceries, but there will be an amount accumulating, unspent, in a variable category somewhere to balance this out. When the fire pay finally comes in, the amount “available” in each category will get padded to help bring us to the next fire pay.

The longer you’re budgeting this way, the less this over-spending will happen as the long-term padding effect starts to kick in.

It’s not perfect, but there really is no easy solution to this irregular income dilemma. At least this method helps to make sure that money’s accumulating in each category and that you never go into your overdraft.

Watch my video on how to use this method in Excel and let me know if you have any questions.


  For better viewing: click on the YouTube icon in the bottom right hand corner of the video’s window.

 

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How much life insurance do you need?

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I was surprised lately when I was speaking to a friend and learned they don’t have any life insurance! We just automatically bought some when we had kids and I thought everyone else did the same. Looking into it some more I was shocked to find out that only 34% of people considered life insurance essential to their financial plan and only 40% of people bought it because of a life event, like having a baby (check out this survey by State Farm).

I guess for a lot of people, deciding how much insurance coverage they need is a daunting task. And maybe people assume that the coverage they get through work is enough (usually somewhere between 2 to 5 times your salary). Well, you know me….I’m not happy until some math has been done, so let’s explore different ways to figure out how much is “enough” coverage.

Firstly, there are a couple of things to keep in mind:

  • Don’t assume that a stay-at-home spouse doesn’t need to be insured. There are paid services involved with raising kids that aren’t in the family’s budget now, but might become expensive if a stay-at-home spouse dies. It’s a worthwhile exercise to calculate what monthly expenses would cost more if that person wasn’t there. Things like daycare, transportation, and the cost of meals might increase if the stay-at-home parent wasn’t there to provide them.
  • Funerals are costly and it’s much easier to deal with the stress of that unexpected expense when it’s in the context of a hypothetical and unlikely event.
  • Straight-up life insurance policies are a better value and more flexible than dedicated policies that pay out in the event of death (i.e. mortgage insurance or credit card balance insurance).

Now, when it comes to actually coming up with a number, consider these things:

  • How dependent the family is on the insured person’s income.

If there are 2 incomes in the household, can they each sustain all the monthly expenses on their own, without any dependence on the other salary? If not, then you need to assess what the deficit would be.

  • Will the family stay in the same home if one spouse dies?

In other words, would the surviving spouse need to maintain the current mortgage and other household expenses on their own if tragedy were to strike?

  • What is the plan for managing the insurance money?

For example, is the intention to pay off some major expenses with the life insurance policy and then have the surviving spouse manage all other monthly expenses on their own? Or alternatively, would the insurance money be invested and only the interest earned used to replace the deceased’s salary on an on-going basis? Both are feasible options, but if the intention is to spend the money, make sure and calculate amounts needed for future large expenses as well (i.e. college costs or supporting aging parents).

Personally, I think a combination of those 2 strategies is smart. We figured out the amount of the salary we would need to replace in order to maintain the status quo in our house. We calculated how much we would need to invest in order to generate that amount, only using the interest and never touching the principal. Then we added the amounts we would need to cover certain large expenses off the top, like funeral expenses.

When you’re calculating how much capital you need in order to generate a certain income, make sure that the numbers you use for estimating are conservative and align with your investing strategy. If you only intend to invest in no-risk GIC’s, then you need to assume you will only be making 1 to 3 percent on your investments and you need to insure yourself accordingly. Alternatively, if you are a savvy investor and confident in your abilities to invest in the stock market, you can probably use a number somewhere between 6 and 15 percent in your calculations.

Once you’ve found a percentage you’re comfortable estimating with, you simply take the amount of annual income you need to generate from the investment and divide it by the percentage. This will tell you how much you need to be insured for in order to generate a perpetual income from the principal, without ever using the principal itself.

Ex: If you need to replace a salary of $50,000/year and you want to assume an 8% return on your investment, and you want to make sure the cost of a funeral is covered up front, then the calculation looks like this:

$50,000 ÷ .08 = $625,000 + cost of funeral = amount of insurance policy

Of course, life insurance is one of those things we buy hoping to never need it, but a little forethought goes such a long way. Most life insurance is very affordable, and really, how can you put a value on peace of mind?


Disclosure: This blog post was written as part of a sponsored program for State Farm to raise awareness about the importance of life insurance. All views expressed are entirely my own, and were not influenced or directed by State Farm. You can learn more about this blogger program and life insurance at GoodNeighbors.com, PlantingMoneySeeds.com, and by following #StartLiving on Twitter.

Should you roll your consumer debt into your mortgage?

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Big question: Should you use the equity in your home to pay off your consumer debt?

Quick answer: Maybe.

Long answer: Let’s do some analysis…whether or not it makes sense to use your mortgage to pay your consumer debt depends on:

  • the amount you owe in consumer debt

If you only owe a small amount, then there’s no need and no point in rolling it into your mortgage. Even if the interest on your mortgage is very low and the interest on your consumer debt is very high, paying the debt over 20 to 30 years would result in paying a lot more in interest in the long run.

  • the amount of equity you have in your home

If using the equity in your home would only pay off a very small portion of the debt, then there’s probably no point in doing it. You wouldn’t achieve the desired effects of freeing up money in your budget or paying down your debt.

  • the % of interest being charged on your debt

I consider anything below 10% to be a low amount to pay on consumer debt and anything above 10% to be high. If all your consumer debt is on vehicles that charge below 10% then there may be no huge benefit to using the equity in your home to pay it down. Chances are it’s possible to pay it down in a reasonable time and stretching it out over 20 to 30 years would result in more coming out of your pocket in the log run.

  • how long it would take you to pay your debt down if you just keep paying it as you are

If you can afford to pay the debt down in as little as 2 to 4 years then there’s no need to stretch it out over 20 to 30 years. Do the math though, you may be surprised at how long it will take to pay the debt down to $0. You can use the calculator here to see how long it will take you to pay it down and how much interest you’ll pay.

  • how much cash you would free up every month

You can use the calculator here to see how much more your mortgage payments would be. Compare your old mortgage payments + the amounts you were paying towards your debt to the new mortgage payments. Would you free up a significant amount of cash each month?

  • how tight your budget is

Are you currently accumulating more debt each month simply because of the payments to the debt? In other words, you just can’t afford the amount of debt you currently have? If that’s the case, then your equity may be your saving grace. As long as you can afford the new mortgage payments and you do not charge one more dollar to a credit card or line of credit, using your mortgage to pay the debt may be a feasible solution.

  • your ability to stay debt-free

If you use up the equity in your home to pay down debt, but are not disciplined enough to stop accumulating more debt, then there is NO POINT in using your equity to help get rid of the debt. If you don’t stop accumulating new consumer debt then all that will happen is you will push yourself closer to a desperate situation where credit counselling and possibly bankruptcy will be your only options.

  • what you’ll do with the “extra” money you now have every month

If all the stars align and this is a feasible way to get rid of your consumer debt, make sure that you use the “extra” money you now have for good instead of evil. My suggestion? Put a portion aside for emergencies, use a portion of it to start a “fun” fund, and invest the rest. Do this every month and the debt should stay gone for good!


 For better viewing: click on the YouTube icon in the bottom right hand corner of the video’s window.