Keep Calm and Stay Liquid: How To Cut Back When Income Drops
Workers who earn a regular salary can expect a steady income every month, but most workers don’t fall into that category.
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More than half (55.7%) of U.S. workers age 16 and older were paid at hourly rates as of 2023, according to the U.S. Bureau of Labor Statistics. Another 10.2% were either independent contractors, on-call workers, temp workers or workers provided by contract firms.
If you fall into one of those categories, chances are you earn an irregular income that can go up or down over time. Here’s a look at what you should do when your income drops — and how you can prepare ahead of time.
Dip Into Reserve Accounts
If you haven’t done so already, now’s a good time to divide your money into separate bank accounts — one for your personal finances and one related to work that you can dip into when your income goes down.
Having this account at the ready is one of the best ways to deal with a sudden dip in earnings, according to Chad Cummings, an attorney and CPA at Cummings & Cummings Law, who previously worked in finance and tax
“What I tell every irregular earner in my practice is: Maintain a separate operating reserve account that covers six months of fixed obligations, including estimated tax payments,” Cummings told MoneyLion. “Structure every recurring bill, from leases to subscriptions, against your floor income — not your ceiling. The goal is to make a bad month boring instead of catastrophic.”
Prioritize Your Bills
Bills don’t stop coming just because your income goes down. When your earnings take a sudden and heavy dip — and you don’t have enough money in your reserve account to pay all the immediate bills — it’s time to prioritize which bills to pay first.
A report from the University of Wisconsin-Madison recommends putting your bills in the following order when you experience a drop in income:
Housing. Includes rent or mortgage.
Basic living expenses. These should cover groceries, medical insurance and utilities.
Car/transit payments. This is especially important if you need transportation to earn a living.
Tax debts. Primarily income taxes, quarterly estimated taxes and property taxes.
After you’ve taken care of those bills, you can work your way down the line to student loans, credit-card bills, household goods and other debts. It’s also helpful to take on side gigs to help fill the earnings gap.
Keep Funding Your Retirement
Cummings recommends making every effort to keep contributing to your retirement accounts when your income drops.
“Don’t skip retirement contributions even in slow months,” he said. “Pay yourself a fixed monthly distribution from the reserve [account] and let the excess accumulate.”
Along the same lines, you should never tap into your retirement accounts during periods of low income.
As Cummings noted, if you fund a SEP-IRA or solo 401(k) plan during high-income years and then tap into those accounts during a downturn, it triggers a 10% early withdrawal penalty plus ordinary income tax on the distribution.
“That creates a tax event in the worst possible year,” he said.
Prepare Ahead of Time
The best way to deal with a drop in income is to take proactive steps that can help you stay liquid and avoid panicking. Here are two things you can do right now, according to a blog from Western & Southern Financial Group:
Make a budget: Estimate your monthly income based on the average over the past several months — not your highest-earning months, although the post does say you can use your lowest ones if you want to establish a safe baseline. Compare your set and averaged monthly expenses to your long-term goals to create a realistic picture of future opportunities to cut back in case your income drops. Your future self will thank you as your budget becomes simple to adjust.
Pay yourself a salary: With your monthly income and expenses documented, pay yourself a salary. Not only will this keep your business assets separate from your personal ones in your fiscal accounts, it will also create a mental space between the two that keeps you mindful of how much you're actually earning. And it will keep business expenditures well away from the money that's "yours" vs. your work's.
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This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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