One reason it can be difficult to budget is because we don’t know what to include in the “income” portion.
You would think it would be easy. Any money you make should be included in your income and spent how you want.
But that actually isn’t true.
The goal of your income on your budget is to always cover at least all your expenses, and getting it right is crucial to helping you build the life you want to live.
This might not always happen if you are just adding your paychecks up, adding them together, and then calling it a day, especially if your checks are not always the same amount.
If you’re in a commission-based or tipped job position—like a sales rep or a restaurant server—some months may be lucrative while some may be pretty bear.
There is even less of a chance of your income covering your expenses if you are planning for income that might not always be there.
Here are five types of income you should never include in your budget.
1. Extra Paychecks
Depending on your pay schedule, some months out of the year will give you an extra paycheck. For my wife, one of those months is this month (October 2020).
If you are paid bi-weekly like she is, there will be two months out of the year where you get a third paycheck.
For the other ten months you will get the usual two paychecks.
For weekly paychecks, it may vary depending on the year, but in most years you will have four months where you will get paid five times instead of four.
The reason you shouldn’t plan your budget around these extra checks is because they don’t always happen.
What happens on months you don’t have three paychecks if you need three paychecks for the amount you are budgeting?
It isn’t fun to scramble to cut costs for ten months out of the year simply because you need more than two paychecks to cover your monthly expenses.
Don’t be surprised when they do come along though. Just because you’re not planning for them within your budget doesn’t mean you shouldn’t have a plan for them.
So what do you do with them?
These extra paychecks are GREAT for reaching your financial goals faster. Use them to bolster your emergency fund, pay off debt quickly, save for a vacation, or buy something you value.
2. Income Tax Refund
I think it goes without saying that you cannot count on an income tax refund as regular money.
Income tax refunds aren’t reliable from year to year, let along planning for them in your budget.
Taxes can change depending on who the president is or who is in Congress. You may usually get a larger refund and then it be significantly smaller the next if new tax laws are passed.
You shouldn’t include these as planned income in your budget, but there is a way to include them as part of your paycheck.
It’s like giving yourself a raise without your boss’s involvement.
Talk to a tax professional on how you can adjust your tax withholdings on your federal and state income tax forms.
You can also adjust your tax withholdings yourself like I’ve done. It’s actually pretty simple, but keep in mind it is always best to talk to a tax professional.
If you do end up continuing to receive tax refunds, do not include it in your budget.
No Christmas is complete without a viewing of National Lampoon’s Christmas Vacation. It’s a classic!
Near the end of the movie, Chevy Chase’s character, Clark Griswold, receives an envelope containing his yearly Christmas bonus and excitedly announces to his family that with it, he’s putting in a swimming pool.
His wife screams and hugs him, the kids are all excited, and the extended family cheers!
Clark also confesses that he had to write the check for the pool in advance and didn’t have enough in the account unless his bonus arrived.
Clark opens the envelope to find his employer paid out bonuses with a Jelly-of-the-Month club membership instead of a large check.
Clark throws a hilarious tantrum and Cousin Eddie sets off to give Clark the one Christmas gift he requested—Clark’s boss delivered to his house with a big ribbon on his head.
In real life, if your company took your bonus away, there wouldn’t be anything you could do about it. You would just have to live with it, whether you planned for it like Clark Griswold did or not.
Use these for something special if they do arrive, but don’t plan for them in your budget as they are not guaranteed. Treat it strictly as extra money if it comes in because that is exactly what it is.
Companies are funny things because they have to balance what is good for their employees with what is good for the business. Sometimes years that means no bonuses.
That is why it is important to not include bonuses in your spending plan.
4. Side Hustle Income
Many of us nowadays have a side hustle that brings in a little extra income, especially with the pandemic forcing us to search for ways to make more money and giving us a bunch of extra time.
Many hobbies can be monetized, and many people use these for their fun money.
That’s totally fine, but unless your income comes at a regular pace, do not include it in your main spending plan.
Instead, have a plan for this income on the side—putting the “side” in “side hustle!”
You could say, “If I receive revenue or income from my side business…” and then have a plan for what you will do. Some things you can do are:
- Reinvest it into your side business to increase your earning potential or get your name out there
- Use it for a dream vacation, especially if you have no plans on taking the business full time
- Pay off debt faster or increase your emergency fund
- Invest for the sole purpose of retiring with more income or retiring early
Again, this all depends on your personal financial goals so do with it what is best for you.
5. Any Other Income that is Not Permanent
Essentially, any income that isn’t permanent should not be included in your main budget.
I know for a lot of us it is instinctual to see money and say “Oh look! I have more money to spend!” But I encourage you to take a step back and only plan for what income that comes in regularly.
If it might not happen, it should not be included.
In budgeting, you want to find your Lowest Probable Monthly Income, or LPMI for short.
It’s s a way of underestimating your monthly income so you never have a month where the budget you are planning for exceeds your actual income.
That way you are only using the income you will definitely receive.
Only using income that you will definitely receive guarantees that you are setting your budget up in a way where your planned income will always take care of your expenses.
From there, you can decide how much more income you need to continue to build the life you want.
This is why budgeting is the root system of your financial tree. Setting up a Root Budgeting System as your budget will help you plan for the best income amount for you and show you exactly what to do with it.
Excluding these five things in your income will help you plan better.
This will give peace of mind knowing that your planned income will be able to support your planned expenses.