What is discretionary income?
Quick insights
- Discretionary income is the money you might have left after paying taxes and essential living expenses.
- It differs from disposable income, which is your income after taxes but before paying for necessities.
- Calculating this number might help you make more informed choices about saving and spending on nonessential items.
Managing a budget involves balancing your needs with your wants. Once your taxes and essential expenses are covered, any money you might have left is considered your discretionary income. Calculating this number may help you plan for future goals or unexpected expenses.
The basics of discretionary income
Discretionary income is the amount of money you may have available to spend, save or invest after you've paid your taxes and all your essential living expenses. These essential costs, often called non-discretionary expenses, include things you need to survive and maintain your household.
Some common non-discretionary expenses include:
- Housing costs
- Groceries
- Utilities
- Transportation
- Health insurance
While these categories are necessary, how much you choose to spend within them is up to you, and reviewing and optimizing these costs may help you increase your discretionary income.
Once these necessary bills are paid, whatever cash remains in your checking account is considered discretionary. You have the freedom to decide exactly where this money goes.
Disposable vs. discretionary income
Discretionary income and disposable income are easy to confuse since they sound similar, but they represent two different stages of your paycheck.
Disposable income is the money you have left after income taxes are deducted from your gross pay. This is slightly different from your take-home pay, which also subtracts other payroll deductions like health insurance or retirement contributions. You may use your disposable income to pay for both your needs and your wants.
Discretionary income takes the calculation one step further. It is what remains of your disposable income after you subtract all your essential living expenses. In short, disposable income pays the bills, while discretionary income could fund your lifestyle and future goals.
Strategies for calculating your discretionary income
Figuring out your discretionary income might help give you a clearer picture of your financial health. Here are a few steps to help you find your number:
- Determine your gross income: Start with the total amount of money you earn before any taxes or deductions are taken out.
- Calculate your disposable income: Subtract your federal, state and local taxes from your gross income. This leaves you with your take-home pay.
- Add up your essential expenses: Tally your monthly costs for housing, basic food, utilities, transportation and required insurance premiums.
- Find the difference: Subtract your essential expenses from your disposable income. The resulting number is your discretionary income.
Common uses for discretionary income
Once you figure out how much extra money you have each month, you might decide how to allocate it. Here are a few common ways people use these funds:
- Building an emergency fund: You might set money aside in a savings account to cover unexpected expenses, like a car repair or medical bill.
- Paying down debt: You could use extra funds to make additional payments on credit card balances or personal loans, which may help reduce the interest you pay over time.
- Saving for long-term goals: You may want to save for a down payment on a house, a new vehicle or your retirement.
- Enjoying life's extras: You might spend this money on dining out, vacations, entertainment or hobbies.
Why discretionary income matters
Reviewing your discretionary income could be a helpful part of creating a budget. It allows you to see exactly how much financial flexibility you might have each month. If your discretionary income is low, you might consider looking for ways to reduce your essential expenses or increase your earnings.
Additionally, this number may play a role in certain financial programs. For example, if you have federal student loans, your loan servicer might use your discretionary income to determine your monthly payment under certain repayment plans. Note that lenders may have specific formulas for calculating discretionary income.
In summary
Calculating your discretionary income might be a helpful step in managing your personal finances. Once you figure out what you have left after essentials, you might feel empowered to make more strategic choices about your spending. This approach may give you the flexibility to fund your lifestyle choices and reach your savings goals more efficiently.
