J.D. Roth on Managing Fluctuating Self-Employment Income
When GetRichSlowly.org founder J.D. Roth quit his job selling cardboard boxes for his family business in 2008 to run his website full-time, he was faced with a new financial challenge: fluctuating income.
Like many self-employed professionals, Roth (pictured) had busy months and slow months, which resulted in stressful swings in cash flow. To gain more stability, he separated his personal and business accounts and began paying himself a fixed salary on a regular basis.
“Pay yourself as if you were an employee,” he advises in this post on the subject. (He sold the blog to QuinStreet later that year, but continues to write for it as an unpaid freelance contributor.) The key, he notes, is to base your salary on your lowest-earning month of the previous year.
“Some people will look at what they made in the previous year, and they’ll pay themselves the average of what they made each month,” Roth tells the Intuit Small Business Blog. “When you budget based on the average, you’re making the assumption that things will remain as good or better going forward. That isn’t always the case.”
Take Home a Modest Paycheck
Instead, Roth pays himself modestly, believing that it’s more prudent to depend only on a minimum of his earnings. Any income above that base amount accumulates in a separate account, which he uses to pay taxes, invest in the business, and grow his personal savings.
This strategy, he says, “leaves some money in the business that builds up that can be used to purchase new computers, if needed, and be an emergency buffer. It forces me to live on less, so I’m not spending beyond my means. It also gives me a large chunk at the end of the year that’s left over that I can pay to myself.”
Another strategy for calculating the appropriate salary — one that’s especially useful for self-employed professionals who have some extremely lean months — is to pay yourself 75 percent of your average monthly earnings.
“Don’t base your income on your best month or on your average,” Roth recommends. “You should give yourself a cushion. Maybe you give yourself a 25 percent margin of error.”
Learn to Live on One Income
Another alternative is to learn to live on a spouse’s or a domestic partner’s salary alone — and set aside everything you earn.
“If you’re in a relationship where you have two incomes, try to live off the stable income that doesn’t fluctuate and use the fluctuating income to save for other goals,” he says. “That way, it becomes a bonus instead of a headache.”
Regardless of your calculations, live on less than you earn. Roth says that young people can benefit most from learning the discipline of living on only 50 percent of their income from the very start.
“If you can do that, then it becomes easier for two people to live off one income,” he says. “[And] you can retire in 15 years instead of 30 or 40.”