Discretionary Income Explained

By Diana Kelly Levey · April 01, 2022 · 6 minute read

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Discretionary Income Explained

You’ve probably heard the phrase “discretionary income” before and thought you knew what it meant, but perhaps the definition that came to mind was vague. It’s money you can spend on “fun things,” right? Kind of. Discretionary income refers to the money you have available after your main obligatory payments and necessities are covered. In this guide, we’ll answer “What is discretionary income,” give examples of this type of income and how to use it, and help you learn how to calculate this money in your budget. It’s 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 paid all the essentials of daily life. These expenses include your mortgage or rent, utilities, car payments or bills, as well as food, healthcare, and occasionally clothing (if it is needed, not just wanted). To phrase it another way, it’s the money you have left after paying for your necessities or needs each month. (And no, a Netflix subscription or your AM latte isn’t a “necessity.”) It’s worth noting that not everyone has discretionary income; some of us struggle just to cover the “essentials” when it comes to paying our bills.

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.

Also worth noting (warning, buzzkill ahead): Discretionary income isn’t just to be spent on cool stuff and fun experiences. A portion of it typically goes towards savings and debt. One key kind of debt to consider: 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.

Examples of Discretionary Income

Many of us might think of discretionary income as “splurge money” that can be used for nonessentials, like going out to eat, vacations, more toys for the kids, clothing, concert tickets, and more. That is true, and your personal budget should accommodate things that come up throughout the year, like haircuts, gifts, holidays, splurge-y food expenses (takeout and pizza delivery, we’re looking at you!), and repairs and replacements — because laptops have a way of dying at the worst possible moment.

But remember: Money isn’t just meant to be spent! Discretionary income can also be used to pump up your financial health and fund your long-term goals. Some of it can be stashed for savings, whether for a down payment on a house or a retirement fund that will have you quitting the 9-to-5 by age 50. Your discretionary income can also go toward paying off credit cards and debts like student loans.

Discretionary Income 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. Remember, 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.

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 taking the kids to a theme park. You could also use discretionary income to make a future dream come true. You could, say, contribute to a child’s 529 plan or their savings plan. 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. That’s a good way to build up an emergency fund if you don’t already have one.

Let’s also shine a spotlight on 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 further damage by decreasing 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 in 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 essential living expenses. As you look at your overall budget and discretionary income, you might benefit from exploring the 50/30/20 rule. This strategy suggests your monthly income should be divided into 50% going toward essential expenses, 30% being used as discretionary income, and 20% allocated for savings, investing, and debt repayment. 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 towards savings and investments. This can be a really helpful way to understand how to “bucket” your money and keep your finances healthy.

Now you’ve learned what discretionary income means: the amount of money left after all of your essential expenses are deducted from your take-home pay. You’ve also seen how it can be used, from fun purchases to paying down credit card or student loan debt, or nonessentials. As you think about these 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.

Get Ready to Bank Better with SoFi

How can a bank help you have more discretionary income? By giving you great interest rates and not deflating your balance with all kinds of fees. And that’s exactly what you’ll find with an online bank account from SoFi. If you become a member and sign up for direct deposit, we offer 1.25% APY, which is a whopping 33x the average checking account rate. We also won’t charge you any minimum-balance or monthly fees and will give you access to your paycheck two days early — sweet! More interest plus less fees equals more cash you can use for your discretionary income!

See the difference a smart partner like SoFi can make to your money.


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