How to Budget as a Freelancer With Feast-Or-Famine Income
Written by
Bradley Schnitzer
From the outside looking in, freelancing seems like a dream job. You can set your own hours, pick your clients, and work when and where you want. But freelancing comes with plenty of pains, too — mainly, the uncertainty of everything.
Freelancers are intimately familiar with the “feast-or-famine” cycle of income. One month, you have so much client work that you consider hiring subcontractors. The next month, all the work dries up. Plus, you lose all the conveniences of being an employee: tax withholdings, retirement accounts, and benefits packages.
With extra costs and fluctuating income, budgeting each month as a freelancer is quite the challenge. However, you don’t need to return to the 9-5 workforce to thrive financially. Follow this guide to take control of your money without sacrificing your freelance career.
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Unpredictable Income Requires Predictable Expenses
One of your cash flows — either income or expenses — has to be predictable if you want to budget effectively.
Most people work 9-5 jobs and have a steady paycheck coming in each month. They have the luxury of budgeting their expenses from a fixed income number. As long as they spend less than their paycheck, they’re fine. But you have to go the other way. Knowing your expenses first helps you determine the minimum amount you must make each month.
Start with your necessary expenses. These include the following.
- Housing: Rent/mortgage, mandatory insurance policies, and property taxes.
- Utilities: Utilities aren’t predictable, but you can estimate. Look at last year’s utility statements, see how much you paid each month, and budget for each month this year accordingly.
- Food: Groceries are the only food considered necessary. Fast food, restaurants, and any other form of dining out are extra.
- Internet: Every freelancer needs an Internet connection to work. Fortunately, Internet plans tend to cost the same amount every month.
- Phone: Phones are essential for freelancers. Avoid going over any data allowances to keep phone expenses predictable. Find a plan with unlimited data if you can afford it. Unlimited data will help keep your phone expense steady.
- Healthcare: Account for medications (prescription and non-prescription) you take regularly. Include copays for regular doctor’s visits, too. Additionally, consider medical bills you’re paying off.
- Transportation: Include your auto payment, insurance, gas, maintenance, and registration if you have a car. If you don’t, budget for any public transit passes you have.
- Minimum payments on debt: Minimum payments are necessary because not paying them can damage your credit score and lead to late fees. Anything beyond the minimum counts as savings because it would reduce your principal and future interest charges.
Once you work out these expenses, look for areas in which you can cut spending. Living lean early in your freelance career can make budgeting easier.
Track Your Income and Establish a Conservative Estimate
Track your freelance earnings for several months. Calculate the average, then subtract 30% of that number for taxes. This is your monthly income for budgeting purposes.
If you have several regular clients, figuring your income is easier. Budget based on your steady clients, and put earnings from one-off projects towards debt or savings.
Open a Separate Savings Account For Taxes
As a freelancer, you don’t have an employer to withhold taxes from your income. Plus, the IRS asks you to pay both the employee and employer portions of Social Security and Medicare taxes. You’re responsible for paying these taxes quarterly to the federal government. If applicable, you have to pay quarterly state and local taxes as well.
Open a separate account to save for your quarterly tax bill. Everyone’s tax situation differs, but saving 30% of your earnings in taxes is a good guideline.
However, accounting software like Quickbooks calculates your tax bill on an ongoing basis — saving you money while ensuring you pay the correct amount. Plus, Quickbooks links you directly to the IRS Electronic Federal Tax Payment System (where you can pay quarterly taxes online) so you don’t have to search for it yourself.
Be Prepared For Emergencies
Most financial advice says to save three to six months of living expenses in case of emergencies. When you have unsteady income, aim for the high end of that ranger. You may consider putting aside even more than six months of expenses.
A high-yield savings account is an excellent place to park your emergency fund. Your money earns interest while it lies in wait — you can use these earnings to top off your fund or work towards a different financial goal. But if you ever need the cash, a high-yield savings account makes tapping your emergency reserves easy.
Don’t Forget About Retirement
As a freelancer, you don’t have an employer-sponsored 401(k) — but you still have access to numerous other retirement accounts.
Let’s cover your individual retirement options first.
- Traditional IRA: The IRS allows you to deduct traditional IRA contributions on your tax return. Withdrawals from traditional IRAs in retirement are taxed at ordinary rates. In 2020, you can contribute up to $6,000 to a traditional IRA. This contribution limit increases each year to account for inflation.
- Roth IRA: Roth IRA contributions are not tax-deductible, but retirement withdrawals are tax-free. Like traditional IRAs, Roth IRAs have a 2020 contribution limit of $6,000.
IRA contribution limits are much lower than the 401(k)’s. Don’t worry — as a self-employed worker, the IRS also sees you as an employer. Consequently, you have access to employer retirement accounts to supplement your IRA savings.
- SEP IRA: Your contributions are limited to the lesser of $57,000 or 25% of your net earnings from self-employment for 2020. The formula for calculating net earnings is a bit complex, but the IRS has a worksheet to help. Many brokers that offer SEP IRAs have calculators and worksheets as well.
- SIMPLE IRA: You can contribute 100% of your net self-employment earnings up to $13,500 as an employee for 2020. On the employer side, you can contribute 3% of your net self-employment earnings.
- Solo 401(k): The same as a traditional 401(k), but it only covers you (and your spouse if you choose). These let you contribute as an employee and an employer. Employee contribution limits are the same as regular 401(k)s. As an employer, you can contribute 25% of your net self-employment earnings. However, employee + employer contributions cannot exceed $57,000 for 2020.
Making Your Income More Predictable
Freelancing doesn’t have to mean putting up with an unstable income forever. Here are a couple of tactics for securing a more stable income while you work for yourself.
Negotiate Retainer Agreements
Retainer agreements bring you the best of both worlds — a stable income and a freelance lifestyle. Under a retainer agreement, you provide your client with a fixed amount of work per a specified time frame. In exchange, your client pays you a fixed monthly sum. You can arrange for the sum to be paid in full at the beginning of the month or you can split it up into weekly payments if you’d like.
If the client requests work outside of the scope of the retainer, you can charge extra. For example, if you’re a freelance writer, you may charge $2,000 per month for up to four monthly blog posts. Perhaps the client requests a 5th post: you could then charge your standard blog post rate. Or maybe you’re a web developer. You could offer a client website maintenance and updates for a fixed sum each month.
To entice clients to sign a retainer contract, offer a small discount. If you typically charge $2,000 for a certain level of service, you could offer a 5% discount ($1,900) for a monthly retainer. After you have enough retainers to cover your regular expenses, you can use your extra capacity for one-off projects to pad your savings.
Tracking each of these retainers is time-consuming, though, especially if you have a client that’s slow to pay. If you want to live on retainer earnings, you must ensure that you get paid on time each month.
Diversify Income Streams
As a freelance, you have more freedom of movement than an employee. However, your income is still tied to your time. You only earn when you finish client projects. But you’ve already proven you can run and market a business. Creating more income streams stabilizes your income in case client work dries up.
Many freelancers diversify their income streams with info products. Books and courses are popular among freelancers. For example, if you’re a freelance programmer, you can release a course on how to become a freelance programmer.
You could branch out into other types of products, too. Back to the freelance programmer scenario, you could build and sell a piece of software.
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A Solution to the Feast-Or-Famine Predicament
Budgeting is tough when you deal with feast-or-famine income, but it’s possible with some effort. Keep your expenses predictable and cut out things you don’t need. Be conservative with your income estimates, save for taxes, set aside ample cash for emergencies, and prioritize your retirement savings. At the same time, stabilize your income by negotiating retainer contracts and diversifying your business’s income streams. Do it right, and you’ll enjoy the benefits of working for yourself without the constant financial turmoil.
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