Wednesday, February 27, 2013

Financial Planning On An Irregular Income

Are you in a career that is feast or famine? Most self-employed folks and those who work on commission face the challenges of an irregular income. I’m familiar with this financial roller coaster since I have been self-employed for all but about 2 years since 1999.

1.) Base your lifestyle on the “famine” times instead of your “feast” times. When you’re starting out, most of your extra resources need to go towards building a reserve. Living out of your cash register or business checking account is an easy way to go broke. You must have a Personal Reserve and a Business Reserve. Your Personal Reserve should be at least 3 months of your “personal” expenses, maybe more depending on your unique situation. How much of Business Reserve do you need? At all times, you should have enough to levelize your income for the next 12 months.

Business Reserve Example: Your monthly obligations are $4,000. You project your income over the next 12 months to be as follows: Jan, Feb, March - $2,000 each month ; April, May, June - $6,000 each month ; July, Aug, Sept, - $3,000 each month ; Oct, Nov, Dec - $5,000 each month. You would need at least $9,000 in Business Reserves. Use the “Reserve” in months where you are short, and replenish it in the good months.

2.) When you bring home a fat paycheck, DON’T go on a spending spree. Give yourself a small bonus as a reward, enjoy a modest celebration, and save the rest.

3.) As your career progresses, average out your yearly income over the past 2 or 3 years, and pay yourself regular monthly paycheck. Base it on real numbers NOT anticipated income that also allows you to continue to reinvest back into your business and set aside money for taxes.

4.) This should probably be #1 but I hate taxes, and I know you do too! Set aside what you will need to pay Uncle Sam off the top of EVERY check. Don’t fall into the trap of relying on that next big paycheck to take care of your income taxes. Designate a separate account to set aside money for taxes based on your effective tax rate assuming you are NOT paying quarterly tax estimates.

5.) Eventually you’ll be in a position to start investing outside of your business, and diversification is crucial. You must reinvest back into your business to keep it viable, but you must also diversify away from your core business. If you are in a real estate related industry for example, your first investment should NOT be real estate. Unless, of course you want to risk losing all your investments along with your business in the next major economic downturn. You CANNOT out smart systemic risk. Believe me I tried and I lost thousands of dollars in the 2008 collapse. Systematic risk can be mitigated only by being hedged. To diversify away from you core business, start with asset classes that are as unrelated to your core business as possible.
6.) Determine what, if any, formal entity is right for your business. For some people it’s OK to always file a schedule C. For others an LLC, S-corp, or C-corp is best. All depends on your business, amount of income, federal and local taxes, and of course liability. Not setting up the right entity can be costly to unravel. A business attorney along with your Financial Planner can help you decide.

7.) Last but certainly not least is you must have all the proper insurance coverage’s based on your situation. Auto and Home. Health Insurance, Business Insurance, Disability Insurance, Life Insurance. I know business owners and self-employed are usually risk takers because I am one. But don’t be a bonehead! Risk Management is the foundation of your financial plan.

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