Wild income swings can play havoc with your finances

Budgeting around an uneven paycheck is no easy feat.

It's a challenge many Americans face. Only 47 percent of U.S. households have "consistent and predictable" bills and income, according to a 2015 survey from The Pew Charitable Trusts. Now a new report from the group finds that many households have substantial shifts.

From 2014 to 2015, about a third of U.S. households had volatile income — a gain or loss of at least 25 percent from one year to the next, Pew found. The median income gain was $20,500, and the median income loss was $25,000. (See chart below.)

Volatility stems from causes both expected and unexpected, said Erin Currier, director of financial security and mobility for Pew. Those might include changes in household composition (say, marriage or divorce) or a transition into or out of the workforce (maternity leave or retirement). Some kinds of work also tend to have more fluctuations (hourly and freelance work, for example, and roles that receive a bonus or rely on commissions).

"Income volatility just makes it hard for families to plan and budget," Currier told reporters on a press call about the report.

Compared to households with stable income, households with volatile income — even those whose income had increased — were more apt to experience a financial shortfall, Pew found. Volatile-income households were also less apt to have savings and to say they could come up with $2,000 in an emergency. (See charts below.)

Financial advisors say there are ways for households whose income fluctuates to plan in ways that could keep them on a more even keel, financially:

The usual rule of thumb on emergency funds is to set aside three to six months of living expenses, but households with volatile income should aim for more — ideally, 12 months' worth, said Kevin Meehan, a certified financial planner and the regional president of Wealth Enhancement Group in Itasca, Illinois. Funding that in up years gives you something to draw from in leaner ones, evening out your income.

A home equity line of credit can provide an extra layer of protection, said Carina Diamond, a certified financial planner and the managing director of SS&G Wealth in Akron, Ohio. But save that for emergencies where you expect to pay off the debt quickly. Don't use it to replace an income shortfall.

"The danger here — and I've seen people fall into this — is they start living ahead," she said. "And then guess what? That money doesn't come in and they start falling into debt."

When you have a good year, try to avoid adjusting your lifestyle to reflect that higher number, said Rick Kahler, a certified financial planner and founder of Kahler Financial Group in Rapid City, South Dakota. Aim to keep your living expenses and budget in tune with that lower income.

That helps you avoid falling into debt should that good year prove to be an exception rather than your new normal, he said.

"Usually we can very quickly adapt to higher income," Kahler said. "The problem comes when it's a spike … there's often a lot of optimism that things will turn around, and by the time it's real clear nothing's coming through, the hole has been dug."

Volatile income can make it tough to juggle bills, so having a good sense of your expenses is key, Kahler said. Divide them into three buckets: Regular recurring bills and commitments, lifestyle expenses and future expenses that are unpredictable but expected (say, medical bills and car repairs). That assessment can help you determine a minimum target to hit for annual income and allow you to better allocate those paychecks, he said.

Monitor your budget as you get a sense of whether you're in for an up, down or average year.

"Be willing to hammer down on those variable expenses," Meehan said. "Pull those back in quickly if your income is at the lower end of the range."

If you receive large payouts — say, an annual bonus or sporadic freelance payments — then it's important to have a plan for that money before it arrives, said Susan Bradley, a certified financial planner and the founder of the Sudden Money Institute in Palm Beach Gardens, Florida.

"There's a tendency to want to go and spend it," she said.

That's not just frivolous, Bradley said, but also playing catchup on necessary expenses or purchases you held off on until pay day. But the result is that you may not be allocating the cash in a way that covers your financial bases.

First, factor in taxes and withholding if the payment comes in as a 1099 rather than W-2, she said. Then consider how long you need that money to last until your next pay day, and put into savings enough to cover your monthly expenses until then. After that, look to funding your rainy day account and other goals like retirement and college savings. Allocate for discretionary spending, too.

Ideally, you'd keep separate savings accounts for each goal, Bradley said. That keeps you from accidentally pulling money meant for one purpose to cover another.

When you can tell a particular year is shaping up to be better or worse than average, check to see if that opens up new strategies. The silver lining of a down year could be that your income is low enough to tackle a Roth conversion, Diamond said.

In a flush year, you may be able to put aside a big chunk of money toward a long-term goal like a child's college education or your own retirement, she said. (But you'll also need to watch tax thresholds for any Roth contributions, and consider filing an appeal to limit the impact on your college-bound student's aid package.)

A year that's substantially up or down may also merit adjusting your income tax withholding.