Disposable Income vs. Discretionary Income: An Overview

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

Individuals and businesses earn income—money for providing goods or services or investing capital in assets like individual retirement accounts (IRAs). Other sources of income include pensions or Social Security. This income may be used to fund day-to-day expenditures and necessities or spend on things people want rather than need.

However, there are subtle differences between disposable income and discretionary income. In this article, we’ll discuss those differences and you’ll learn how to calculate your discretionary income. If you have a student loan, knowing your discretionary income will help you calculate the repayment of your loan using an income-based repayment plan.

Disposable Income

Disposable income is one of the economic indicators used to analyze the state of the economy. The amount of net income a household or individual has available to them 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.

For example, suppose a household has an income of $250,000, and it pays a 37% tax rate. The disposable income of the household is $157,500—that is, $250,000 – ($250,000 x 0.37). Thus, the household has $157,500 to spend on necessities, luxuries, savings, and investments.

Disposable Income and the Stock Market

In the U.S., a large increase in disposable income means an increase in the stock market value, as stock valuation occurs when jobs are plentiful and spending is up. An increase in demand for goods and services means the manufacturing and service industries bump in 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 open a high-interest 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.

Discretionary Income

Discretionary income is the amount of income a household or individual has to invest, save, or spend after taxes and necessities, like mortgages or rent, utilities, student loans, or credit card debts are paid. Discretionary income is a subset of disposable income, and therefore there are some similarities between the two income types.

But there is one key difference: Disposable income does not take necessities into account. It simply represents the funds you have post-taxes to use on both necessities and fun.

Discretionary Expenses vs. Non-Discretionary Expenses

Non-discretionary income is used to pay for necessities such as rent, loans, clothing, food, bill payments, goods and services, and other typical expenses.

For example, suppose an individual has an income of $100,000 and pays an income tax rate of 35%. The individual has transportation, rent, insurance, food, clothing, and other necessities totaling $35,000 a year. Their discretionary income is $30,000 or the amount left after subtracting taxes and necessities. This is calculated as $100,000 – ($100,000 x 0.35) – $35,000 for the year.

Discretionary income can be used to pay for vacations, investments into retirement accounts, luxury items, or any good or service that is not necessary (as opposed to food, housing, healthcare, transportation, and utilities.) In a business setting, essential expenses could include salaries for employees, payroll software, and shipping costs. Discretionary expenses for a business might include holiday parties or special gifts for customers.

Discretionary Income Considerations for Student Loans

Understanding how your discretionary income impacts any 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 even family size. You must meet specific requirements in order to be eligible for these federally income-based repayment plans.

Revised Pay As You Earn Repayment Plan (REPAYE Plan)

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

Pay As You Earn Repayment Plan (PAYE Plan)

The PAYE plan charges around 10% of your discretionary income (i.e. income after taxes), but never more than the 10-year standard repayment plan amount.

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 of 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, when you are applying for a federal income-based student loan repayment plan, your discretionary income is calculated a little bit differently. Under REPAY, 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 discretionary income is the difference between your adjusted gross income (AGI) and 150 % of the U.S. Department of Health and Human Services (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.

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.

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 data helps economists analyze and make predictions about the ability of consumers to make purchases, pay for living expenses, and save for the future.

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 is a common measurement used by economists and refers to the amount of money earned per person in a region or nation. The United States had an average household disposable income of $45,284 per capita as of December 2020, according to the OECD website.

Not surprisingly, the United States ranks at the top of the wealthiest countries with the highest disposable income per capita. Other countries that rank in the top ten with high disposable incomes per capita include Luxembourg, Switzerland, Germany, and Australia.

How to Grow Disposable and Discretionary Income

The most straightforward way to increase both your disposable and discretionary income is to earn more. Getting a raise, finding a higher-paid job, or doing side work can help, but this is not always an available option. If you have the same income, finding ways to minimize your tax liability is another route, but you may need to employ the help of an accountant.

You can also try to cut down on your expenses. For instance, buying generic or store brand items instead of name brands. Cutting down on utilities usage by opening the windows instead of turning on the A/C or setting the temperature on your thermostat or hot water heater a bit lower will add up over time. Finding ways to cut costs is one of the easiest ways to increase your available funds.

Finally, try to pay off debts quickly, focusing on those with higher interest rates. Credit cards, for instance, can easily eat into what you have left over at the end of every month. While paying off outstanding debt balances may actually reduce your discretionary income in the short run, it will lead to more later on.

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 your disposable income goes down, you will have less discretionary income, which in turn can impact financial markets and the overall economy.

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 150% of the poverty guidelines, as per your state and family size, and takes into account any rise or fall in your income.