Financial Terms / C - D / Discretionary income

What is discretionary income?

Discretionary income is the money you have left after paying for necessities and taxes. It's the cash you can spend, save, or invest as you choose. To understand it better, let's break it down:

Your income goes through two stages:

1. Disposable income: This is what's left after taxes. It's your take-home pay.

2. Discretionary income: This is what remains after you've paid for essentials like:

- Housing (rent or mortgage)

- Food

- Utilities

- Transportation

- Insurance

- Debt payments (student loans, credit cards)

Discretionary income is for non-essential expenses. You might use it for:

• Vacations

• Dining out

• Entertainment

• Luxury items

• Hobbies

• Savings or investments

It's a key measure of financial health. The more discretionary income you have, the more flexibility you have with your money. Some experts suggest aiming for about 30% of your paycheck as discretionary income.

Remember, discretionary income can change. It's affected by things like inflation, debt, and changes in essential costs. To increase it, you could pay off debt, reduce necessary expenses, or find ways to boost your income.

Calculating Discretionary Income

To figure out your discretionary income, start with your disposable income - the money left after taxes. Then, subtract all your necessary expenses. These include:

• Rent or mortgage

• Utilities

• Food

• Transportation

• Insurance

• Debt payments

What's left is your discretionary income. It's the money you can spend, save, or invest as you choose.

For a more precise calculation, follow these steps:

1. Find your Adjusted Gross Income (AGI) from your tax return.

2. Look up the federal poverty guideline for your family size and state.

3. Multiply the poverty guideline by 150% (or 225% for the new SAVE plan).

4. Subtract this amount from your AGI.

5. The result is your discretionary income.

Remember, this amount can change yearly based on your income, family size, and where you live. It's crucial for setting up income-driven repayment plans for student loans. The government uses it to determine how much you can afford to pay each month.

Importance of Discretionary Income

Discretionary income plays a crucial role in your financial health and overall well-being. It's the money you have left after paying for necessities and taxes, giving you the freedom to spend, save, or invest as you choose.

Having discretionary income offers several benefits:

1. Financial flexibility: You can cover unexpected expenses or take advantage of opportunities.

2. Improved quality of life: You're able to afford non-essential items like vacations, entertainment, or luxury goods.

3. Investment potential: You can grow your wealth by investing in stocks, bonds, or other assets.

4. Economic indicator: Economists use discretionary income to gage business conditions and consumer spending patterns.

5. Health and well-being: Studies show that people with discretionary income are more likely to report better health.

To increase your discretionary income, consider these strategies:

• Reduce taxes through legal means

• Pay off debt to lower monthly expenses

• Invest in yourself through education and skill-building

• Build an emergency fund to cover unforeseen costs

Remember, discretionary income varies among individuals. Some might not have any after covering necessities, while others may have a significant amount. Regardless of your situation, understanding and managing your discretionary income is key to achieving financial stability and personal goals.

Strategies to Increase Discretionary Income

To boost your discretionary income, you need to focus on smart financial moves. Start by tracking your spending. Write down everything you buy, even small items like a soda. This helps you see where your money goes and what you can cut.

Next, create a budget. Figure out your after-tax income and list all your expenses. Aim to spend less than you make so you can save more. The 50-30-20 rule is a good starting point. Put 50% towards needs, 30% for wants, and 20% for savings.

Look at your monthly costs. Can you cut any subscriptions? The average American spends $219 a month on these. Cutting half could save you $109.50 monthly. Also, try to lower your utility bills. Use LED bulbs, unplug devices when not in use, and set your thermostat wisely.

Consider your housing costs. If you're renting, could you move to a cheaper place or get a roommate? For homeowners, look into refinancing your mortgage to lower payments.

Lastly, tackle your debt. Try to consolidate high-interest debts into a single, lower-interest loan. This can reduce your monthly payments and help you pay off debt faster.

FAQs

Q: What is discretionary income and how is it utilized?

A: Discretionary income is what remains from your disposable income (the money left after taxes) once all essential living costs like food, housing, and clothing are covered. This remaining amount can be used for savings, investments, or additional spending on non-essential items and services.

Q: Can you explain what discretionary income is?

A: Discretionary income refers to the funds available for spending, saving, or investing after essential expenses (such as taxes and basic living costs) have been deducted from your total income.

Q: What does it mean when someone refers to 10% of their discretionary income?

A: Referring to 10% of discretionary income typically relates to financial obligations that are calculated as a percentage of this income. For example, if your discretionary income is USD 12,000 annually, 10% would be USD 1,200. This amount could represent the annual sum payable on a debt like a student loan, equating to monthly payments of USD 100.

Q: What are some effective ways to allocate discretionary income?

A: A practical method to budget discretionary income is the 50/30/20 rule. This guideline suggests using approximately 50% of your after-tax income for necessities, 30% for discretionary expenses, and allocating the remaining 20% towards savings or debt repayment.