If you have a freelance or otherwise variable (and in many cases – unpredictable) income, then saving for retirement can be tricky. Setting up an automatic savings program is risky since you may not have enough income to cover your payment on any given month, but leaving the contribution up to disciplined manual contributions could mean discovering that the money has been spent already and there is none left to save.

Here is a solution that allows you to effectively save for retirement on a variable income while reducing the discipline required to do it all on your own. This solution is best implemented once you have at least a year or two of variable income under your belt in your career, so you can start by making some basic calculations as outlined in the steps below.

Step One: Determine What Percentage of Your Income You Will Save

Ideally you have already determined what percentage of your annual income you can afford to (and are prepared to) save given the retirement lifestyle you wish to have. If not, now is the time.

EXAMPLE: Purely for the purposes of this illustration, I will assume that you have an average annual income of $50,000 and are prepared to save 10% ($5,000) per year for retirement. (These are by no means the recommended numbers, as your retirement plan depends on many factors, including your age, income, investments, and financial prospects. Please consult with a financial planner to incorporate this strategy into your personal financial plan).

Step Two: Determine Your Lowest Income Month

Since this strategy is best accomplished with a history of your variable income to rely upon. Now is the time to review your records. What was your lowest income month? Is this a function of the time of year, or a fluke? If you see a trend of lower-income months, then identify your lowest predictable income month.

If you anticipate that there could be lower income months than what you have historically experienced, then use an estimate of what your lowest income month could look like. Try not to be too stingy with this number though, since an unpredictably low income month can be dealt with at the time of earning (or lack thereof). Adjustments can always be made. Try instead to be realistic, and stick close to your actual lowest-income months.

EXAMPLE: Although the average monthly income for a $50,000 career is $4167, let’s say your lowest income month is $2,000.

Step Three: Set up An Automatic Savings Plan

This automatic savings plan will go directly into your retirement savings account, and should reflect your desired retirement savings percentage, applied to your lowest income month. The reason for this is the assumption that if you saved 10% of your average annual income (which works out to over $400/month in the example), you may find yourself too strapped for cash to keep a standard automatic savings plan in place. If you base it on your lowest income month, then you stand a chance of being able to maintain this automatic savings plan over the long run.

EXAMPLE: In step one, you decided to save 10% of your annual income. In step two, you determined that your lowest income month is likely to be $2,000. Thus your automatic retirement savings plan should be 10% of $2,000 – which is $200 per month. This should be affordable, even given the lower income. Read on for variable income management tips to help you navigate fixed expenses and variable income.

Step Four: Make Manual Contributions Each Month (or Periodically)

Although you are saving $200 per month, this will not satisfy your need to save 10% of your annual income. It is simply a baseline contribution. Thus each month, you must also tuck away 10% of your income over and above your lowest income base line.

EXAMPLE: One month you earn $3,000. This is $1,000 more than your $2,000 lowest-income baseline, so you need to save 10% of the extra $1,000 (which is $100).

Another month you have a great run and earn $8,000. Subtract your $2,000 base line, and you are left with $6,000. 10% of $6,000 is $600, which is the amount you need to save for retirement that month.

Note: Although you do not necessarily need to make manual contributions each and every month if it is a huge hassle, it is imperative that you at least set aside this money somewhere that it won’t be touched and can be earmarked for your retirement contribution for this year.

Step Five: Review the Plan Annually

If you find that your lowest-income months are trending higher, then increase your baseline automatic contributions each year to reflect the new low-income month. This way you can continue to save a proportionate amount of your income automatically, and you reduce the amount you will have to save manually.

EXAMPLE: It has been a while since your income was as low as $2,000. Instead, you are now finding that your lowest months are $3,000. Increase your automatic contributions to $300 per month (10% of $3,000).

Alternately if times are tough and your income has dropped, you can lower your automatic contributions accordingly.

Advantages of This Plan

• Despite a variable income, you can take advantage of dollar cost averaging for retirement.
   
• At least some of your retirement savings is automated, which increases your chances of overall success in saving for retirement. Leaving 100% of your retirement contributions to manual discipline is rarely successful, especially if you are not incredibly fastidious about setting money aside.
   
• When your annual income is higher than expected, you will still be saving an accurate and proportionate percentage. Assuming you can write off retirement contributions, it is beneficial for tax purposes to be saving a percentage of your income rather than a fixed dollar amount.
   
• When your annual income is lower than expected, you won’t have to satisfy retirement contributions that leave you too strapped for cash.
  

Additional Variable Income Management Tips

Since some months have a disproportionately large income and others similarly small, managing all your monthly expenses is tricky. To combat this, you must ensure that you do not spend everything you take in on the higher-income months.

Instead, keep the extra income on high-income months tucked away in a high-interest savings account which can be accessed to cover your expenses on low-income months. This is not your emergency fund: this is your slush fund to cover off your variable income. This is a basic principle of living with a variable income which will help you navigate the stress of managing the expenses during low-income periods.