What Is Discretionary Income? How to Calculate, With Example

Reviewed by Thomas BrockReviewed by Thomas Brock

Disposable income and discretionary income are key economic indicators used to gauge companies’ and individuals’ financial stability.

However, they are different. Disposable income is what you have left over after taxes. Discretionary is what you have left over after taxes and necessities, such as a mortgage payment or rent.

Key Takeaways

• Disposable income is the money that is available to invest, save, or spend after deducting income taxes.
• Discretionary income is what a household or individual has to invest, save, or spend after necessities are paid.
• Discretionary income is a subset of disposable income.
• There is one key difference: Disposable income doesn’t take necessities into account. It simply represents the funds you have post-taxes to use on both necessities and fun.
• The U.S. Department of Education uses your discretionary income to calculate payments for income-based repayment plans.

Disposable Income

Disposable income is the amount of net income a household or individual has available to invest, save, or spend after income taxes. When you receive a paycheck, disposable income is the net amount you receive in your check. Disposable income minus all necessary payments equals discretionary income.

Advisor Insight

Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, New York

The terms disposable and discretionary income are sometimes used interchangeably, but there is a big difference in terminology for people that work in the financial, banking, or economic worlds. Very simply, disposable income is money you have after taking out/paying your taxes. Discretionary income is money left over after paying your taxes and other living expenses (rent, mortgage, food, heat, electric, clothing, etc.). Discretionary income is based on and derived from your disposable income.

Disposable Income and the Stock Market

In the U.S., a large increase in household disposable income typically leads to a rising stock market, as jobs are plentiful and spending is up. An increase in demand for goods and services boosts the manufacturing and service industries’ production and output.

Consumer spending is critical to the strength of the stock market and the United States’ gross domestic product (GDP). When disposable income rises, households may decide to invest and save (for instance, in an individual retirement account (IRA) or a high-yield savings account) or spend on purchases.

When disposable income is down, consumers often spend and invest less, which will impact the stock market. When consumers are forced to become more thrifty, this may lead to a decrease in sales and earnings for corporations and businesses, causing stocks to slump.

Disposable Income Per Capita

Disposable income is a key metric monitored by financial analysts and government officials because it provides a useful gauge for the overall strength of a country’s economy. Disposable income is what economists use to monitor how much households are spending and saving.

The Organisation for Economic Co-operation and Development (OECD) compiles economic data for 37 nations, tracking and reporting the household disposable income per capita. Per capita income refers to the amount of money earned per person in a region or nation. The United States ranks at the top of the wealthiest countries with the highest disposable income per capita, at $51,147 per capita, according to the OECD website. Other countries that rank in the top ten with high disposable incomes per capita include Luxembourg, Switzerland, Germany, and Australia.

Discretionary Income

Discretionary income is the amount of income a household or individual has to invest, save, or spend after taxes and necessities, are paid. (Necessities include mortgages, rent payments, utilities, student loans, and credit card debt.)

Discretionary Income Considerations for Student Loans

Understanding how your discretionary income impacts student loan debt can help you take advantage of federal student loan programs, such as income-based repayment plans.

There are four income-based plans offered by the federal government, each with discretionary income requirements. These plans set your student loan payment often below what you would owe on a standard plan. They offer a more affordable option that is based on income and family size. You must meet specific requirements in order to be eligible for these federal income-based repayment plans.

Saving on a Valuable Education (SAVE) Plan

This plan takes into account your discretionary income and allows you to pay approximately 10% of your income to your student loans.

Important

On July 18, 2024, a federal appeals court blocked the SAVE plan until two court cases centered around the IDR plan can be resolved. The Department of Education has moved borrowers enrolled in the SAVE plan into an interest-free forbearance while the litigation is ongoing.

The Department of Education has also outlined options for borrowers who were nearing Public Service Loan Forgiveness (PSLF)—borrowers can either “buy back” months of PSLF credit if they reach 120 months of payments while in forbearance or switch to a different IDR plan.

Income-Based Repayment Plan (IBR Plan)

This plan accounts for 10% of your discretionary income, but only if you are a new borrower on or after July 1, 2014. Similar to the PAYE plan, you will not be charged more than the 10-year standard repayment plan amount. If you are a new borrower on or after July 1, 2014, the amount goes up to 15% but again, never more than the 10-year standard repayment plan.

Income-Contingent Repayment Plan (ICR Plan)

This plan will charge you a repayment amount in whichever is the lesser amount, 20% of your discretionary income, “or what you would pay on a repayment plan with a fixed payment over the course of 12 years, adjusted according to your income.”

In this case, if your discretionary income goes up, so do your loan payments.

Note that when you are applying for a federal income-based student loan repayment plan, your discretionary income is calculated a little bit differently. Under SAVE, IBR, PAYE plans, your required monthly payment is generally a percentage of your discretionary income and it is tallied as such, according to the Federal Student Aid Office. “For all three plans, your required monthly payment is generally a percentage of your discretionary income. For the SAVE Plan, your discretionary income is the difference between your adjusted gross income (AGI) and 225% of the U.S. Department of Health and Human Services (HHS) Poverty Guideline amount for your family size and state. For the PAYE and IBR plans, your discretionary income is the difference between your AGI and 150% of the HHS Poverty Guideline amount for your family size and state.” In addition, your payments are capped at a percentage depending on the program, your salary, and your family size.

The Federal Student Aid website provides a loan simulator tool that is useful if you are trying to decide which repayment plan to use. The page provides a series of questions to get you started on your journey to paying back your student loans.

How to Calculate Your Discretionary Income

When you calculate your discretionary income:

1. First begin with your disposable income: all the income left over after you pay taxes.
2. Next, you need to tally up and calculate all of your necessities like rent or a mortgage, utilities, loans, car payments, and food.
3. Don’t forget to deduct taxes that will be owed.
4. Once you’ve paid all of those items, whatever you have left to save, spend, or invest is your discretionary income.

What Is the Difference Between Discretionary and Disposable Income?

Disposable income represents the amount of money you have for spending and saving after you pay your income taxes. Discretionary income is the money that an individual or a family has to invest, save, or spend after taxes and necessities are paid. Discretionary income comes from your disposable income.

What Are Examples of Discretionary Income?

Discretionary income is the money you have after paying your taxes and other living expenses. Discretionary income can come out of a paycheck, Social Security, or any other income you earn. Examples of its use would be going out to dinner and a movie, ordering tickets to a show, or going on vacation.

What Is a Good Discretionary Income?

A good amount of discretionary income means you can cover all your necessities and still have money left over to invest, save, or spend. According to some experts, a good amount of discretionary income is 30% of your paycheck after necessities are paid.

How Is Discretionary Income Calculated for Income-Based Repayment of Student Loans?

The U.S. Department of Education calculates borrowers’ discretionary income as the gross after-tax income for the year minus 225% of the poverty guidelines according to their family size and state.

The Bottom Line

Disposable income and discretionary income both provide economists with data to measure consumer spending.

Your discretionary income comes out of your disposable income (after-tax money), which is used to pay for all necessities and non-essential goods and services. After you pay all your living expenses, the money left over to save, invest, or spend is your discretionary income.

If you are applying for federal student loan income-repayment plans, the U.S. government will calculate your discretionary income as the gross after-tax income for the year minus 225% of the poverty guidelines, as per your state and family size. It also takes into account any rise or fall in your income.

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