Dubai: For most people, saving for retirement seems like a daunting endeavour and reaching that finish line requires that you spend decades setting aside cash.
While that’s tricky, it’s more daunting when you’re trying to save steadily while your income fluctuates every month. If your income varies, statistics show you’re among six in every 10 people worldwide.
You might be employed in a job that may pay out only part of the year or maybe you own a seasonal business. You may even be earning your pay from working freelance or on a pre-set contract.
One month, your income may not be enough to float your personal living expenses, while other months, you might make enough to cover off six months of expenses.
So not only is basic budgeting a different story when you have a variable income, but so is saving for retirement.
How can you plan for retirement when your income isn’t consistent? And what can you do to ensure you stay on track with retirement savings no matter what?
Here are some moves that may help you answer most of the questions that arises in situations like yours.
Using these step-by-step techniques you can take some of the guesswork out of saving for your own retirement, while still balancing out the need to cover other expenses.
It also eases the discipline required to do it manually in lump sums. This is implemented when you have a few years of variable income patterns under your belt for both stability and ease of projections.
Step #1 - Determine what percentage of your income to save
Take a peek at your annual income for the last few years.
If you already know how much money you need to save each year to satisfy your retirement goals, simply translate that number into a percentage of your earnings.
Example: Purely for the purposes of this illustration and ease of calculation, let’s assume you have an average annual income of Dh100,000 and aiming to save 10 per cent (Dh10,000) per year for retirement.
(These are not recommended numbers, as your retirement plan depends on many factors, including your age, income, investments, and financial prospects.)
Step #2 - Determine your lowest income month
In reviewing your records and income trends, find the low-income periods of the year. What was your lowest income month?
Was your lowest income month a one-off event, or a somewhat predictable function of the season or industry for example? Err on the safe side of your low income predictions.
In identifying your trends, now is the time to estimate your lowest income month that you will experience in the next 12 months, based on experience and educated estimates.
If you have an unpredictably lower-than-usual earning spell, you can adjust your variable income retirement savings plan on the go. The idea is to get a working estimate to start with.
Example: Although the average monthly income for a Dh100,000 career is over Dh8,300, let’s say your lowest income month is Dh4,000.
Step #3 - Set up an automatic savings plan
Based on the first two steps (being your annual retirement savings percentage and your lowest income months), it is time to set up an automatic savings plan.
Simply apply the percentage you wish to save towards retirement to your lowest income month. This ensures that you are always saving something towards retirement.
However, this also ensures that when money is tight, the amount you are saving is proportionate to your variable income (and not the retirement savings end-game).
This strategy is also a nice way to take advantage of ‘cost averaging’ within your retirement investments. ‘Cost averaging’ helps you lower the amount you pay for investments and minimise risk.
So instead of purchasing investments at a single point and a single price, with cost averaging you buy in smaller amounts at regular intervals, regardless of price.
Example: In step one, you decided to save 10 per cent of your annual income. In step two, you determined that your lowest income month is likely to be Dh4,000.
Thus your automatic retirement savings plan should be 10 per cent of Dh4,000 — which is Dh400 per month. This should be affordable, even given the lower income.
Step #4 - Make manual contributions each month (or periodically)
Dh400 per month in regular retirement savings won’t satisfy your goals of saving 10 per cent of your income for retirement.
This is what we will call your ‘base-line’ contribution. So, each month that your income exceeds the base-line threshold, you must also tuck away 10 per cent of your income over and above your base-line.
Example: One month you earn Dh6,000. This is Dh2,000 more than your Dh4,000 lowest-income baseline, so you need to save 10 per cent of the extra Dh2,000 (which is Dh200).
Another month you earn more, let’s say Dh12,000. Subtract Dh4,000 base-line, and you are left with Dh8,000. 10 per cent of Dh8,000 is Dh800, which is what you need to save for retirement that month.
Note: Making manual contributions could be a hassle, especially if you want to simplify your finances and the process of saving money.
As you will likely have already discerned in living with a variable income, you must pad your low-income months with savings from the higher-income months to meet all your financial obligations.
If you do not have a system in place to achieve this, it can be as simple as setting up an online savings account and transferring your monthly manual retirement contribution electronically.
Then periodically you can contribute the accumulated balance to your retirement account. However, ensure not to borrow from this account.
Step #5 - Review the plan annually
As your income rises, you would have to review your plan and your monthly income trends.
You may then find that your base-line amount is too low. If that is the case, then simply increase your automatic contributions to reflect the new low-income base-line.
You can then continue to save a proportionate amount of money for your retirement, and will reduce the amount you have to contribute manually.
Example: It’s been long since your income was as low as Dh4,000, and you now find your lowest months are at least Dh5,000. Increase automatic contributions to Dh500 per month (10 per cent of Dh5,000).
Alternately if times are tough and your income has dropped, you can lower your automatic contributions accordingly.
Advantages of this plan: Surveys show a constant rise in variable income of the world population over time. So as your income increases, you are still saving a proportionate amount of money for retirement.
Given that navigating automatic payments can be stressful given a variable income, this strategy allows you to take advantage of cost averaging for your retirement investments.
By automating at least part of the plan, your chances of meeting your retirement goals is increased. Statistics show that business owners often don’t save for retirement.
This is either because they believe the business is their retirement, or because they are unable to shell out money for yet another expense.
Leaving 100 per cent of your retirement contributions to manual discipline is rarely successful, financial planners caution, especially if you are not incredibly careful about setting money aside.
Lower income months won’t leave you strapped for cash with an ambitious retirement contribution plan based on your average income (which doesn’t factor the highs and lows of a variable income lifestyle).
Note: On those higher-income months when you invest the extra cash manually for your retirement, you would be well-served to tuck away additional funds in a similar manner (but in a different account).
This is to cover off other fixed monthly expenses and have on hand when your income in other months is not quite sufficient. This is your safety fund to compensate for your variable income.