How can individuals plan for retirement when they don’t know when they will see their next paycheck? Many conventional budgeting tips and savings goals don’t apply to them. Understanding if earning an irregular income affects your future is vital. More importantly, you should know how to achieve financial stability before retirement.
Here are some things people with unconventional incomes should keep in mind when planning an effective retirement strategy.
What It Means to Have an Irregular Income
Thousands of nontraditional jobs exist. Entrepreneurs, seasonal workers, freelancers, contractors, salespeople, and servers are some of the most common. Whether they earn money from overtime, interest, bonuses, tips, or commission, they all deal with the same issue — the number on their paycheck constantly changes.
While earning well above your average can feel great, experiencing a few back-to-back lean months can cause stress to creep in. You’re not alone if you worry about finances because of an irregular income. Only 13.3% of people say they feel confident in meeting personal financial goals and planning for retirement.
Many people realized what it meant to have an irregular income during the height of the COVID-19 pandemic. While some lost their jobs when things closed down, others seized the opportunity to seize nontraditional career opportunities. During the “Great Resignation” — record-high quits brought on by the pandemic — millions of people left their jobs searching for higher pay, more convenient hours, or a better work-life balance. More than 4.5 million people quit in one single month of 2021 alone — a shocking 2.86% of the 157 million Americans who made up the U.S. workforce as of 2019. Although many found the remote flexibility and work-life balance they sought in nontraditional jobs such as freelancing, they had to sacrifice their financial stability.
Why Planning Around an Irregular Income Is Challenging
Having an irregular income doesn’t necessarily mean you’re not making enough. However, the sudden fluctuations in earnings make budgeting and planning for retirement challenging. Even if you’re not living paycheck to paycheck, unexpectedly making half what you usually do is a big financial hit.
That said, nontraditional workers whose tips, commissions, overtime, or bonuses account for a large percentage of their income often make less than they need to cover essentials. If you fit into this category, you’re more likely to have inconsistent hours, lower wages, and fewer benefits, impacting your earnings and expenses.
A one-size-fits-all budget only works if your expenses and earnings remain steady. Many people take out high-interest loans to compensate for a sudden drop in cash flow, making saving difficult. When short-term financial goals feel unattainable, achieving long-term objectives seems impossible.
Building up your savings can be challenging if you don’t know your financial future. As a result, unforeseen expenses, emergencies, and economic crises have a lasting impact. While financial experts say everyone should save 20% of their earnings at minimum, that percentage won’t always be as impactful on an irregular income.
How Income Volatility Influences Your Financial Mindset
In behavioral economics, mental accounting refers to a cognitive bias. It states that people tend to view the value of their money differently depending on how they plan to use it. Therefore, they are prone to irrational spending, saving, and investing decisions. For example, a professional might consider their quarterly bonus a windfall instead of income.
People who experience income volatility often use mental accounting to justify overspending. They usually think of anything above their typical take-home pay as extra. They use these funds on luxuries instead of treating them like regular earnings, resulting in inadequate savings.
One expert recounts one of their former jobs, describing how an executive they worked with consistently spent the annual 30% bonus he received on top of his six-figure salary. Most of it went toward his yearly family vacation — he viewed a huge portion of his earnings as a windfall instead of part of his income.
While spending this way feels good initially — it triggers a rush of feel-good hormones — it often leaves people feeling guilty. Any large, sudden expenses must be pulled from savings at this stage. Research shows income volatility induces financial stress, especially for low-income earners. As a result, they may not make the best decisions with their finances.
When you live on an irregular income, mental accounting sets you back. Instead of treating anything above your typical cash flow as extra, proactively earmark it for a beneficial purpose. Making a mental note to save or invest instead of leaving it in your checking account waiting to be spent helps you minimize the temptation to impulse buy or spend carelessly.
Overcoming Income-Related Financial Stress Is Key
Steeling yourself against spending a big bonus or hours of overtime pay is challenging. After all, you earned it — and probably spent the last few months worrying about affording the basics. However, saving extra when you make more than usual helps balance out the lean months, so your income volatility isn’t as noticeable.
Once you’ve stabilized your income, you can focus on long-term objectives. How much do you want in your savings account one decade from now? Can you reach that goal by saving enough from each paycheck, or must you invest? Once you find the answers to these questions, develop backup plans to increase flexibility.
Make sure you look beyond retirement instead of considering it the finish line. If you were born after 1959, your full retirement age is 67 instead of 62 — meaning many benefits won’t kick in entirely until then. How will you manage your finances after you’ve left the workforce?
A reverse mortgage is one way to give yourself more financial stability in retirement. You become eligible at 62 years old if you own a house. You take out a loan using the equity in your home — meaning the amount you actually own — as a guarantee, never owing more than the value of your property, even as interest accumulates.
Whether you plan on taking out a reverse mortgage or investing in stocks, you should structure your retirement plan to relieve income-related financial stress after you leave the workforce. You may assume you only need to reach your 60s to stop worrying about money, but that may not be the case.
Why You Can’t Expect Retirement to Change Things
Are you patiently waiting for retirement, thinking it will provide you with a stable income? According to the U.S. Social Security Administration, average benefits total about $1,871 monthly. This amount is the equivalent of around $10.80 hourly. Moreover, you may be unable to count on a pension if you’re like most people.
Pension plans used to guarantee employees would receive regular monthly payments in retirement. Nowadays, they are virtually nonexistent. According to the Bureau of Labor Statistics, only 15% of people in the private industry — meaning those working nongovernment jobs — had access to a defined benefit plan in 2022.
Since the average rent for a one-bedroom apartment in the U.S. is roughly $1,739 monthly, Social Security benefits won’t leave much left over. Covering other necessary expenses may be difficult without support, which isn’t always available as soon as you retire. For instance, Medicare doesn’t kick in until you’re 65.
There’s also the cost of sudden, unexpected events to consider. Many financial advisers agree emergency funds should cover expenses for three to six months, with some claiming people should have enough for up to 12. Building savings to the recommended level is challenging on a low, fixed income.
You shouldn’t count on retirement to give you financial stability. Although you’ll have a steady income, you won’t make much. Frankly, you need savings. Even if you plan on living frugally, you need enough to cover emergencies. Take care of your future self by creating and sticking to a retirement planning strategy.
What Should You Strive to Save by Retirement?
Many people set lofty goals when planning for retirement. Some financial advisers say people should have over $1 million by the time they leave the workforce. However, according to the Federal Reserve, the average American had $333,940 in their retirement account in 2022. In reality, many people — especially younger adults — have less than six figures put away.
Since retirement is decades away for many people, they assume they’ll receive a windfall or make high-earning investments in time. Individuals whose income differs from paycheck to paycheck should have a more tangible goal.
Instead of deciding on an arbitrary dollar amount, they should calculate their expenses to determine how much they will need. Then, they should add enough funds to cover potential emergencies or opportunities. After subtracting income like Social Security benefits and Medicare, they get the minimum amount they must save for retirement.
People must consider how to reach their goals best. They should plan ahead because they likely can’t use traditional avenues. For instance, just 46.3% of nontraditional workers had access to an employer-sponsored retirement plan in 2021. While investing is technically a viable option, it isn’t ideal for those who lack liquidity or can’t contribute consistently.
On an irregular income, putting aside a fixed percentage of each paycheck for retirement isn’t as effective as it should be. Instead, individuals should scale how much they save, setting a hard minimum to ensure they stay on track. Skipping out on non-necessities occasionally may be tough, but the eventual payoff is worth the effort.
Tracking your month-to-month earnings and expense fluctuations helps you adjust your budgeting strategies. It lets you uncover trends, which allows you to anticipate change better. Even if your income doesn’t remain steady, knowing how it will shift gives you more control over your financial future.
Planning for Retirement Despite an Irregular Income
Planning for retirement despite income volatility is possible. Here are some of the steps you should take.
1. Create a Dynamic Budget
Since your paycheck changes, your budgeting strategy must be just as dynamic. Unlike a rigid fixed plan, a variable budget considers sudden dips or surges in earnings. It helps you be more realistic about how you spend and save, enabling you to tackle short-term goals so your financial objectives for retirement become clear.
A zero-sum budget is an excellent example of this approach. You give every dollar a purpose until you have nothing left over at the end of each month. Instead of keeping it in your checking account — which enables impulse buying and mental accounting — you assign all your funds to various wants and needs.
2. Consider Getting an Annuity
An annuity is a contract between you and an insurer, bank, or brokerage firm. It pays out in a lump sum or a series of payments. You can buy one to guarantee you have an income stream in retirement. Best of all, you don’t need your employer’s help — you can do this as an individual. Once you pay in, the other party pays you back, adding in the investment income gains.
3. Set up a Passive Income Stream
A passive income — no matter how small — can make a huge difference in your financial stability and mindset. You can earn money passively, whether selling stock photos, posting subscription-based courses online, or renting out an empty bedroom. Getting started should be easy if your side gig fits your hobbies or job.
Consider investing if you have enough funds. You don’t need to be an expert stock trader to succeed. Instead, you can become a silent partner, providing capital to a business in exchange for a cut of its profits. You wouldn’t be involved in the daily operations and are protected from personal liability for financial obligations, making it a low-risk strategy.
The Reality of Income Volatility’s Effect on Retirement
People who teeter on the edge of barely making rent and having enough to splurge are almost hardwired to spend recklessly. Their work forces them to prioritize short-term financial goals and encourages them to consider extra funds as fun instead of savings. Retaining savings will be challenging if they let their situation determine their finances.
While growing savings despite income volatility is challenging — and may require sacrifices along the way — it is possible. Irregular income earners shouldn’t treat it as an exercise in self-discipline. Instead, they should think of each paycheck as an opportunity to set themselves up for success and financial freedom in the future.
Featured Image Credit: Photo by Nataliya Vaitkevich; Pexels
