Discretionary income is less than both total income and disposable income because it’s income you can use at your discretion. Since everyone has to pay for certain essentials, such as food and housing, you have to subtract those costs to determine your individual discretionary income.
How Does Discretionary Income Work?
For most people, discretionary income matters because it’s the amount of money left in your budget that you can allocate toward spending and saving. You’ll distribute that leftover income among expenses such as retirement savings, debt payments, dining out, entertainment, and anything else you want to do with your money. In some cases, though, discretionary income has a more specific definition. If you have federal student loans and choose an income-driven repayment plan, for example, discretionary income is used to determine how high your monthly loan payments will be. These plans require you pay a percentage of your discretionary income, which varies depending on each plan.
How To Calculate Discretionary Income
For Individual and Family Expenses
You can calculate your discretionary income simply by subtracting the cost of your necessities from your take-home pay, and you can do so on a monthly or annual basis. This example shows how to calculate it annually:
Determine your total income. For most people, this is their annual salary, as well as income from any part-time work. For example, if your job pays $48,000, that would be your annual income.Subtract for taxes. The specific amount you’ll owe depends on your filing status, your state, and your deductions. For this example, let’s say your annual payroll taxes are $8,000.Subtract for essential expenses. This would include your rent or mortgage, utilities, groceries, insurance premiums, and payments for other essentials. Let’s assume these add up to $25,000 annually.What’s left over is your discretionary income. In this case, your discretionary income would be $15,000. This would be the money left over to spend on everything else, such as saving for retirement, paying debt, entertainment, and dining out.
For an Income-Driven Repayment Plan
For income-driven repayment plans, discretionary income isn’t just calculated by subtracting your fixed costs from your total income. To make sure payments are fairly determined for each borrower, a standard formula is used to calculate discretionary income for student loan payments. Your discretionary income is calculated in one of two ways:
If you’re on the Income-Based Repayment (IBR) Plan, the Pay As You Earn (PAYE) Repayment Plan, or loan rehabilitation, your discretionary income is determined by calculating the difference between your annual income and 150% of the federal poverty level based on where you live and your family size.If you’re on the Income-Contingent Repayment (ICR) Plan, your discretionary income is calculated by determining the difference between your income and 100% of the federal poverty level based on your state and family size.
You can find the poverty guidelines used for this calculation on the website of the Department of Health and Human Services. Depending on the payment plan you choose, you will pay between 10% and 15% of your discretionary income—the amount calculated above that varies for each individual—each month.
Discretionary Income vs. Disposable Income
Disposable income and discretionary income aren’t the same, although they are commonly thought to be. Disposable income is higher than discretionary income because it’s calculated only by subtracting taxes from your earnings rather than subtracting both taxes and the cost of necessities. For this reason, discretionary income can provide a more accurate picture of the money you have available. The table below is a hypothetical example illustrating the difference between discretionary and disposable income if you earn $48,000 a year.
