Discretionary income is the extra money you have after paying for necessary expenses. It’s “discretionary” because how you use it is up to you and your own discretion. It’s money you’re free to spend, save or invest as you like, because your essential priorities are already paid for.
To calculate your discretionary income, start with adding up your monthly essential expenses, including fixed costs, like rent and insurance, and variable costs, like food. Subtract the total from your monthly after-tax income (in other words, the amount in your monthly paychecks, after your employer deducts for taxes). That’s your discretionary income, the amount you have for non-essential “wants.”
In short, discretionary income equals gross income minus taxes and necessary expenses.
If you have student loan payments, discretionary income is an important calculation. The Department of Education uses it to set your repayment plan and on how much you should pay every month.
Discretionary income is different from “disposable income,” which is the money left over only after paying your income taxes. Disposable income typically still needs to cover essential expenses, like rent, utilities, health care and food.
In short, disposable income equals gross income minus Income taxes
Understanding your discretionary income is important to making a household budget, planning for the future and allocating funds for emergencies.
A common rule of thumb for household budgets is the 50-30-20 rule, where 50% of your income goes to your needs, 30% for your wants and 20% towards savings. Once 50% of your income has been allocated to needs, the rest is considered discretionary.
Under the 50-30-20 rule, you can spend, save and invest your discretionary income as you like. And you might think “discretionary” just means your shopping budget. But it’s more than entertainment, splurges, extras and luxuries. It’s also dream vacations, cars, weddings and other milestone events.
A lot of things that require saving and investing have to be allocated from your discretionary income. Be mindful that savings are pulled from your discretionary income.
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With a postgraduate degree in commerce from The University of Sydney, Pranay has his finger on the pulse of the finance industry. Breaking down complex financial concepts is his forte.