When it comes to personal finance, discretionary income plays an important role. You can think of it as the money left in your pocket after the essentials have been taken care of—the amount you can direct towards spending, investing, or saving. Discretionary income is what you have left after taxes and cost-of-living expenses are covered.
What is Discretionary Income?
Published October 3, 2024
6 min read
Table of contents
Key Points About: Discretionary Income
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Discretionary income is the money you have after taxes and necessary expenses.
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You can roughly calculate your discretionary income by taking your annual income after taxes and subtracting it from your cost-of-living expenses.
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Discretionary income can impact your budget and what student loan repayment programs you may have available.
What is discretionary income?
Imagine your take-home pay as a pie. Discretionary income is the slice you can savor, devoted not just to the needed expenses but also the extras. When essentials like groceries and rent take their slice, discretionary income can cover things like a weekend getaway, the latest tech device, or even investing in ventures that could bring even more money down the road.
Did you know?
Discretionary income can help you cover the cost of the things that you want. But you can increase your spending power even more with a credit card.
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Understanding discretionary income can help you balance your budget. It shows you how much you can spend on the things you want without stretching your finances. Consider how you're using your discretionary income currently and the ways you can use it to enhance your life.
How is discretionary income different from disposable income?
Some people may confuse discretionary income with disposable income, but they are not the same thing. Discretionary income is the money you have left after you pay for all your necessities. You can think of discretionary income as ‘fun’ money. You can use your discretionary income for things like movie tickets, vacations, or even put it into savings.
The Treasury Financial Experience defines your disposable income as your gross income after taxes. It is. the money you have left for both your needs and wants, your bills and anything else you want to spend on.
What is a discretionary expense vs a non-discretionary expense?
When it comes to your finances, two types of expenses play a significant role: discretionary and non-discretionary. Understanding the difference between these two can help you calculate discretionary income (more on that later).
Non-Discretionary Expenses: The Essentials
Non-discretionary expenses (or cost-of-living expenses) are the must-haves in your financial equation. These are the costs you can't avoid and include things like:
- Housing (rent or mortgage)
- Transportation
- Food
- Utilities (electricity, water, etc.)
- Insurance
- Healthcare
- Childcare
- Basic clothing
Discretionary Expenses: Your Choices
Discretionary expenses are the funds left over after covering your essentials. This is where you can decide how to spend your extra money. It includes things like:
- Vacations
- Investments (retirement accounts, etc.)
- Luxury items
- Anything that's not essential (unlike food, housing, healthcare, etc.)
In a business context, essential expenses are what keep the business running—employee salaries, software costs, shipping, etc. Discretionary business expenses are considered optional and could involve things like holiday parties or special customer gifts.
Understanding these expense categories helps you make smart financial decisions, whether it's in your personal life or business endeavors.
How to calculate discretionary income
To calculate discretionary income, you'll have to subtract your cost-of-living expenses from your after-tax income.
Let's break it down with an example. Imagine you have an annual income of $55,000. After taxes, you're left with $45,000. Now, consider your cost-of-living expenses amounting to $25,000 for the year. The math is simple: deduct your cost-of-living expenses from your after-tax income, which leaves you with $20,000—the discretionary income you have at your disposal.
Why is discretionary income important?
Discretionary income allows you to know how much wiggle room you have in your budget. Plus, it can help you adjust to any major life changes. For example, any shifts in your employment status may impact your discretionary income.
Understanding discretionary income is one way that you can become financially empowered, ensuring that your budget and future plans align with your income reality.
Discretionary income and student loans
Discretionary income can help you when it comes to managing your student loan debt. That’s because many federal student loan programs have income-driven repayment plans. These plans revolve around your income and are tailored to what's left after covering your essentials.
The Department of Education calculates discretionary income a little differently for student loan borrowers. They use a standardized discretionary income based on your earnings, family size, and state of residence and their current poverty guidelines—individual expenses not included.
How does discretionary income impacts credit cards?
While federal student loans may use your discretionary income to mold your student loan repayment plan, credit card issuers typically don’t look at your discretionary income. Still, your discretionary income can still play a key role in good credit card management habits.
Imagine this scenario: You have a credit card with an available credit limit of $15,000. Meanwhile, your discretionary income stands at $10,000. Your current discretionary income may make it harder to settle the $5,000 difference. As a result, you may accumulate debt and interest. One way you could avoid a scenario like this is by making sure your card spending does not exceed your discretionary income. Even if you are tackling debt, you can use your discretionary income to give you an idea of the monthly payment you can afford.
Discretionary income can help you build a blueprint for responsible credit card use and master the art of budgeting. With this knowledge in hand, you can make more responsible decisions and take charge of your financial future.
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