What Is Discretionary Income and How Do You Calculate It

Discretionary income is the money you have left over after paying taxes and covering your necessary expenses. These necessities typically include basic living costs, such as housing, utilities, food, healthcare, insurance, transportation, and minimum debt payments.

What’s left over — your discretionary income — is money you can use for things like eating out, entertainment, travel, clothing, electronics, and gym memberships. You can think of discretionary income as the money available for the wants in life vs. the needs.

However, discretionary income doesn’t necessarily have to be spent. You can also put it toward savings, extra debt payments, or other financial goals.

What follows is a closer look at what discretionary income means, examples of discretionary income, how to calculate discretionary income, and ways to make the most of it.

What Is the Meaning of Discretionary Income?

Discretionary income is defined as the amount of money left from your after-tax income after you pay for essential expenses. Typical examples of these recurring costs include housing, utilities, groceries, medical care, insurance premiums, transportation, and monthly debt obligations.

In other words, discretionary income is generally what’s left after you’ve covered your needs. A streaming subscription, restaurant meal, or dally latte generally isn’t considered a necessity.

However, discretionary income doesn’t have to be used solely for fun purchases and leisure activities. You can use some of it to build savings, make extra debt payments, or work toward other financial goals. How you use this money depends on your priorities and financial situation.

7 Examples of Discretionary Income and Expenses

Discretionary expenses are generally purchases that aren’t essential to meeting your basic needs. Here are some common examples:

Entertainment and Eating Out

This category can include dining out, drinks, takeout, and specialty coffees. Entertainment expenses such as concert, theater, and movie tickets are also typically discretionary, as are museum admission, books, magazines, streaming services, and similar purchases.

Vacations and Travel

Taking a vacation, whether you travel across the world or take a weekend trip closer to home, is generally considered discretionary. Transportation costs may be necessary for things like commuting to work, but leisure travel and vacation expenses are generally considered a want rather than a need.

Luxury Items

Luxury expenses can range from a high-end vehicle to designer clothing, jewelry, or other premium goods. While clothing and a car may be necessities, choosing more expensive versions when less costly options would meet your needs generally makes the additional expense discretionary.

Memberships and Hobbies

Gym memberships, yoga or Pilates classes, crafting supplies, musical instruments, and similar hobby-related expenses are usually discretionary. While these activities may contribute to your health or well-being, they generally aren’t essential expenses.

Personal Care

Some personal expenses are necessary, while others are discretionary. A basic haircut or shampoo, for example, may be considered a need, while expensive salon services, manicures, massages, and high-end hair and skincare products are generally wants.

Upgrading Items

If your current phone, computer, furniture, or other belongings are still functional but you decide to replace them with newer or more expensive versions, the upgrade is generally a discretionary expense. The same may apply to optional home renovations, such as remodeling a bathroom for aesthetic reasons rather than because of needed repairs.

Gifts

Buying gifts for family and friends is generally considered discretionary because it’s not an essential living expense. However, how you categorize gifts in your budget may depend on your circumstances and priorities.

How Is Discretionary Income Used?

Discretionary income can be used for everyday wants, but it can also help you make progress toward financial goals. For example, you might use it to:

•   Spend on wants: Use discretionary money for dining out, entertainment, hobbies, travel, and other purchases you enjoy.

•   Save for short-term goals: Put money in a high-yield savings account earmarked for goals such as a vacation, down payment on a home, new car, or other planned purchase.

•   Pay down debt: While minimum debt payments are generally considered essential expenses, you can use discretionary income to make additional payments and potentially reduce interest costs.

•   Build long-term savings: You can direct discretionary income toward retirement accounts, college savings, or other long-term financial goals.

•   Give to charity: Charitable donations are another way to use money that isn’t required for your basic living expenses.

How to Calculate Discretionary Income

The basic formula for calculating discretionary income is:

Discretionary Income = After-Tax Income − Essential Expenses

Start by determining your average monthly take-home income, which is the amount you receive after taxes and other payroll deductions. You can review several months of bank statements through online banking or check your pay stubs to get an accurate figure, particularly if your income varies.

Next, add up your essential monthly expenses. These may include:

•   Rent or mortgage payments

•   Utilities

•   Groceries

•   Minimum debt payments, such as credit cards, student loans, or auto loans

•   Insurance premiums

•   Necessary medical expenses

•   Transportation costs

•   Other expenses required to maintain your basic standard of living

Subtract your total essential expenses from your monthly after-tax income. The amount remaining is your estimated monthly discretionary income.

For example: Suppose your monthly take-home pay is $5,000 and your essential expenses total $3,500. Your discretionary income would be:

$5,000 − $3,500 = $1,500

That $1,500 could be used for discretionary spending, savings, extra debt payments, or other financial priorities.

Factors That Affect Discretionary Income Calculation

Several factors can influence how much discretionary income you have available, including:

•   Income level: Higher earnings can increase discretionary income, assuming essential expenses don’t rise at the same rate.

•   Living costs: Housing, food, transportation, and other costs can vary significantly by location. Higher essential expenses generally leave less money available for discretionary uses.

•   Debt level: Required payments on loans and credit cards reduce the amount of money available after essential expenses are covered.

•   Taxes: Changes in federal, state, or local taxes can affect your take-home pay and, therefore, your discretionary income.

•   Inflation: When the prices of necessities rise, you may have less money left over for discretionary expenses.

Recommended: Monthly Income Calculator

What Is a Good Amount of Discretionary Income?

There isn’t one specific amount of discretionary income that’s considered “good.” It depends on your income, cost of living, debt, financial goals, and personal priorities. Generally, having enough money left after covering essential expenses to save, make extra debt payments, and spend on some wants can indicate that your budget has room for flexibility.

The 50/30/20 budgeting guideline can provide one way to think about how to allocate your take-home pay. Under this approach, about 50% goes toward needs, 30% toward wants, and 20% toward savings and additional debt payments.

For example, if your monthly take-home income is $5,000, the guideline would allocate $2,500 to needs, $1,500 to wants, and $1,000 to savings and other financial goals. However, these percentages are guidelines rather than rules. If your essential expenses are higher than 50% of your income, you may need to adjust the proportions.

How to Increase Your Discretionary Income

If you want more money available for discretionary spending or financial goals, you generally have two options: reduce essential expenses or increase your income.

Here are some strategies to consider:

•   Review recurring expenses: Look for opportunities to lower the cost of bills such as insurance, internet, phone service, and subscriptions. Even relatively small monthly reductions can add up over time.

•   Reduce everyday costs: Meal planning, shopping around for groceries, using public transportation when practical, or finding lower-cost alternatives can help reduce necessary spending.

•   Increase your income: A raise, new job, freelance work, or part-time income can increase the amount of money you have available after essential expenses.

•   Pay down debt: Reducing debt can eventually lower required monthly payments and interest costs, potentially freeing up more money for other priorities.

•   Consider your housing costs: Housing is often one of the largest expenses in a budget. If your housing costs are putting significant pressure on your finances, moving or finding a less expensive housing arrangement could have a meaningful impact.

Managing Your Discretionary Income for Financial Success

Once you know how much discretionary income you have, the next step is deciding how to use it. A simple strategy is to give your money a purpose before you spend it.

•   Set priorities: Decide which goals matter most to you, such as building an emergency fund, paying off debt, saving for a major purchase, or contributing to retirement.

•   Create separate buckets: Consider dividing discretionary income among spending, short-term savings, and longer-term goals. This can make it easier to enjoy some of your money without losing sight of larger priorities.

•   Automate your savings: Set up automatic transfers to a savings or investment account so that some of your discretionary income goes toward your goals before you have an opportunity to spend it.

•   Give yourself spending limits: Setting a monthly amount for discretionary purchases can help you enjoy your money while avoiding overspending.

•   Review your plan regularly: Revisit your budget when your income, expenses, or goals change. Your discretionary income can fluctuate over time, so your spending and saving priorities may need to change, too.

Discretionary Income vs Disposable Income

The terms “discretionary income” and “disposable income” are sometimes used interchangeably, but they have different meanings.

Key Differences

While both terms refer to money available after certain financial obligations are met, they differ in what has already been deducted.

•   Disposable income: This is generally the income you have left after taxes are deducted. It represents the money available to spend, save, or use for other purposes.

•   Discretionary income: This is the portion of your after-tax income that remains after you have covered essential expenses. It’s the money that may be available for wants, additional savings, extra debt payments, and other nonessential uses.

For example, if you earn $6,000 per month before taxes and have $1,000 withheld for taxes, your disposable income is $5,000. If your essential expenses then total $3,500, you have $1,500 in discretionary income.

The Takeaway

Discretionary income is the money left after taxes and essential expenses are paid. Knowing how much you have can make it easier to decide how much to spend on wants and how much to put toward savings, debt repayment, and other financial goals.

There’s no universal amount of discretionary income that everyone should have. Instead, focus on creating a budget that covers your needs while leaving enough flexibility to make progress toward your goals and enjoy some of your money along the way. Tracking your income and expenses regularly can help you make the most of the money you have left after covering your needs.

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FAQ

Does student loan debt affect discretionary income?

Yes. Required student loan payments are generally considered an essential expense when calculating discretionary income for personal budgeting purposes. The higher your required monthly payment, the less money you have left for discretionary spending, saving, or other financial goals. Making extra student loan payments can further reduce your discretionary income in the short term, but it may help you pay off the debt sooner and reduce interest costs over time.

How does inflation impact my discretionary income?

Inflation can reduce your discretionary income by increasing the cost of essential expenses such as groceries, housing, utilities, and transportation. If your income doesn’t increase at the same rate as your expenses, you’ll have less money left after covering your needs. You may need to adjust your budget, reduce discretionary spending, or look for ways to lower essential costs until your income catches up.

Is discretionary income considered taxable?

Discretionary income itself isn’t a separate type of income that is taxed. It’s a budgeting term describing the money left after taxes and essential expenses. Taxes are generally calculated based on your taxable income, not on how much money you have left after paying your bills. Because taxes are already accounted for when calculating discretionary income, you generally don’t pay an additional tax simply because you have discretionary income.

How does discretionary income impact financial planning?

Knowing your discretionary income can help you determine how much money you have available for financial goals after covering essential expenses. You might use it to build an emergency fund, pay down debt faster, save for a major purchase, contribute to retirement, or spend on wants. Tracking discretionary income can also help you identify whether your current spending aligns with your priorities and make adjustments when your income or expenses change.

Can discretionary income be invested?

Yes. Discretionary income can be used to contribute to investments or other long-term financial goals after you’ve covered essential expenses and addressed higher-priority needs. For example, you might contribute to a retirement account or a taxable investment account. Before putting discretionary income toward long-term investments, consider maintaining an emergency fund and paying down high-interest debt depending on what makes the most sense for you.

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