Discretionary income is defined as the cash you have available to spend after your necessary payments are covered. Those necessities are typically made up of basic living expenses, such as housing, utilities, food, healthcare, and insurance costs. (In some cases, minimum payments toward debt may be included as well.)
So what does discretionary income equal in daily life? It’s the post-tax money you can put toward things like eating out, entertainment, travel, clothing, electronics, and gym memberships. You might think of discretionary income as paying for the wants in life vs. the needs.
In this guide, you’ll learn more about the definition of discretionary income, read examples of this type of income and how to use it, and understand how to calculate this money in your budget. It can be an important number to know, as you’ll see, especially if you’re repaying student loans.
What Is Discretionary Income?
Discretionary income is the amount of post-tax income that is left over after you have paid for all the essentials of daily life. These expenses include your mortgage or rent, utilities, and car payments or bills, as well as food, healthcare, and occasionally clothing (if it is needed, not just wanted). To phrase it another way, no, a Netflix subscription or your AM latte isn’t a “necessity.”
It’s worth noting that not everyone has discretionary income; some people struggle just to cover the “essentials” when it comes to paying their bills.
• Gig, seasonal, and part-time workers: The concept of discretionary income can get a little more complicated if you aren’t a person who gets a steady paycheck. If you have a variable income due to the nature of your work (maybe you’re a gig worker or freelancer), you’ll need to make sure you have enough money set aside in savings if you have a shortfall.
If your income dips and you can’t pay for the basics in life, let alone have some discretionary income, that could mean you’ll get hit with overdraft or late fees or wind up with excessive credit card debt to pay off.
• Discretionary income and savings: Also worth noting (warning, buzzkill ahead): Discretionary income isn’t just to be spent on cool stuff and fun experiences. It’s wise to put a portion of it toward savings. Some people will include debt payments as part of the “necessities” bucket of your budget; others will say that a portion of discretionary income is what goes toward debt.
One key kind of debt to consider in this scenario: student loans. There are four programs for repaying federal educational loans in which your discretionary income can be a factor. It’s vital to make sure you have the right income-driven repayment plan (IDR) that works for your financial situation when it comes to paying down federal student loans.
What if despite your best efforts to pay back your loans, you are still feeling the financial pinch? It’s a common situation as basic bills and student loans conspire to vacuum up all your moolah. Refinancing your student loans to a lower rate can help free up additional discretionary income each month.
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7 Examples of Discretionary Income and Expenses
Now that you know what discretionary income is, it’s worth mentioning that the phrase is sometimes used interchangeably with discretionary expenses. To be clear, discretionary income is what is spent on discretionary expenses.
And what are discretionary expense examples? Here are several:
1. Entertainment and Eating Out
This category includes such expenses as dining out, getting drinks, splurge-y takeout food (pizza delivery, we’re looking at you!), and fancy coffees. In terms of entertainment, the following would be considered discretionary: Concert, play, and movie tickets; museum admission; books, magazines, and streaming services; and similar costs.
2. Vacations and Travel
Taking a vacation, whether you go to the other side of the planet or an hour’s drive away, is not a necessity, despite how you may feel about it.
3. Luxury Items
These expenses could be anything from a pricey sportscar to designer clothes to jewelry to wine. While clothing and a car may be necessities in life, when you pay extra for top-notch prestige brands, you enter the realm of discretionary expenses.
4. Memberships and Hobbies
Yes, joining a gym or taking up a musical instrument are admirable things. But they are not vital to your survival. For this reason, things like yoga or Pilates classes, crafting supplies, and similar expenses are considered discretionary.
5. Personal Care
A basic haircut or bottle of shampoo may not be discretionary, but pricey blowouts, manicures, massages, skincare items, and the like are.
6. Upgrading Items
If your current phone is functional but you get the latest one, that’s a discretionary expense. The same holds true for being bored with your couch and getting a new one or remodeling your bathroom just because.
7. Gifts
Of course you want to show you care for your loved ones. But buying presents for others isn’t vital to survival, so this should be earmarked as a discretionary expense.
Recommended: How to Save on Streaming Services
Income vs Disposable Income
If you are wondering how income vs. disposable income stacks up, here’s the difference. Income refers to all the funds you have coming in, whether from your salary, any side hustles, interest or dividends, and other sources.
Disposable income, however, is what is left of your post-tax money after you have paid for your necessities, as described above. If, say, you follow the popular 50/30/20 budget rule, 50% of your money goes toward needs (necessities), 30% would go toward wants (discretionary expenses), and 20% toward saving. Together, those account for all of your after-tax money, aka your disposable income.
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How Is Discretionary Income Used?
Discretionary income can be used for a number of fun things, from buying the latest mobile phone to taking a pal out for their birthday to spending a day at a theme park with the kids. You could also use discretionary income to make a future dream come true. You could, say, contribute to a fund for your next vacation or the down payment on a house. Another way to allocate discretionary income is to use it for home improvement projects, especially ones that could increase the value of your home. Heck, you could even save it in your bank account, plain and simple, if you wanted.
Also, it’s wise to recognize the fact that some people may need to use their discretionary money for an income-based repayment plan to pay down student loan debt. There may not be a lot of wiggle room there. Others must put this money toward paying down their credit card bills; those high-interest debts can grow over time and do damage to your credit score.
(One tip for those who get paid every other week: When you get an “extra” paycheck that doesn’t need to go to bills, consider it discretionary income that you could put toward an extra payment on debts or to toss into savings.)
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How to Calculate Discretionary Income
One way to calculate your discretionary income is to calculate your take-home pay each month and subtract your “fixed” or “necessary expenses” from that. The money you have left over is your discretionary income which can be used for the kinds of expenses we highlighted above.
What if, when you tally your discretionary income, you wound up with a negative number? This means you do not have any earnings left over to address discretionary expenses. In this situation, it’s important to keep spending under control and look for ways to free up funds.
One other angle to consider about this topic: If you have student loans to pay off, discretionary income can be used for an income-based repayment plan.The federal government offers income-based plans, and each one has its own discretionary income requirements.
These programs often put your student loan payments notably under what you might otherwise pay. Some of the factors taken into consideration are income and family size; you also must meet certain requirements to qualify for these repayment plans. You can see how the options stack up by plugging your details into the federal government’s loan simulator tool.
What Is A Good Amount of Discretionary Income?
When you’re considering how much discretionary income you should have, you might want to consult a discretionary income calculator. Many options for these calculators are available online.
Hopefully you have some money left each month after you’ve paid your basic living expenses. As you look at your overall budget and discretionary income, you might benefit from exploring the 50/30/20 rule, as noted above.
Example of Using 50/30/20 Rule to Calculate Discretionary Income
If your monthly net (take-home) income was $5,000, $2,500 would be siphoned off for your “needs,” $1,500 would be allotted for discretionary income, and $1,000 would go toward savings and investments. This can be a really helpful way to understand how to “bucket” your money and keep your finances healthy.
As you think about discretionary income and related concepts, you’ll probably realize how important it is to have a budget; this will inform where your money has to go as well as what’s left after those bills have been paid. It will help keep you on track for your discretionary income, reining in excessive spending and guiding you toward saving well and staying out of debt. There are a variety of different budget methods; try a couple and see which works best for you.
💡 Quick Tip: When you overdraft your checking account, you’ll likely pay a non-sufficient fund fee of, say, $35. Look into linking a savings account to your checking account as a backup to avoid that, or shop around for a bank that doesn’t charge you for overdrafting.
Discretionary vs. Disposable Income
The phrases “discretionary income” and “disposable income” might be used interchangeably in conversations among your friends, but — sorry — that’s not necessarily correct.
• Disposable income is how much money you have left from your earnings after tax withholdings are taken out but before deductions are also removed. That’s likely going to be a much higher number than your discretionary income.
• Discretionary income is the amount left after your taxes and deductions (like health insurance, retirement contributions, etc.) are taken out, and then you’ve paid all of your essential living expenses (home, utilities, food, car).
It’s important to be aware that these definitions may be used differently in some circumstances, like if a court is going to garnish your wages or back-owed tax payments during a bankruptcy consideration. These are distressing circumstances, yes, but they happen every day to regular people, so it’s good to have the vocabulary down if you ever face these situations.
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FAQ
What is the meaning of discretionary income?
Discretionary income is defined as the cash you have available to spend after your taxes are deducted and necessary payments are covered.
What is an example of discretionary income?
Here’s an example of discretionary income: If your post-tax earnings were $100K and you spent $50K on necessities and $20K went into your retirement savings, the remaining $30K would be discretionary income.
What is the difference between discretionary and disposable income?
Discretionary income is the money that you spend on non-essential items, or the wants in your life vs. needs. Disposable income, however, is your total after-tax income.
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