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What Is Discretionary Income?

Understanding how discretionary income works can impact everything from student loan repayment to credit card budgeting.

Chris Scott

Contributing Writer at Tally

May 6, 2021

Consumer spending accounts for approximately 70% of the United States economy. On a broad level, spending can be broken down into two categories: discretionary and non-discretionary. 

Non-discretionary spending includes the essentials required to live, such as food and rent. Discretionary spending is any remaining non-essential goods and services. 

In this article, we take you through everything you need to know about discretionary income. Not only do we cover what it is, but we’ll also touch on why it's important, how it's calculated and why it relates to your credit cards. This article should help you understand why discretionary income is an important figure for your personal finances. 

What is discretionary income? 

To put it simply—it's income that you can use at your discretion. Discretionary income is any money you have remaining in your bank account after taxes and essentials. In other words, it's your net income less what you need to spend to live.

Examples of essentials that you would deduct from your income to calculate your discretionary income include: 

  • Rent or mortgage

  • Food

  • Utilities 

  • Your car or gas (if you use it to get to work) 

  • Basic clothes 

Therefore, your discretionary expenses are those spent on non-essential goods and services. Examples include: 

  • Dry cleaning 

  • Alcohol and tobacco 

  • Entertainment (such as concerts or movies) 

  • Vacations

  • Hobbies 

  • Television and other subscriptions

  • Gifts 

  • Food consumed at restaurants 

Remember that discretionary income represents the money you have left after accounting for income taxes and essentials. Though you can choose to spend these leftover funds on discretionary expenses, you also have the option to save or invest them. 

What is the difference between discretionary and disposable income? 

Too often, people use the terms discretionary income and disposable income interchangeably. However, the two terms are technically different. 

Disposable income is merely your gross income minus taxes, perhaps more commonly known as net income or your take-home pay. Whereas discretionary income subtracts your essential expenses, disposable income does not. 

So, let's say that your annual income is $50,000, and you pay $9,000 in taxes. Your disposable income is $41,000. You cannot calculate your discretionary income with this information alone, as you have not yet purchased or budgeted for any essentials. 

How is discretionary income calculated?

The formula for discretionary income is: 

Discretionary Income = Gross Income - Taxes - Necessary Expenses 

In the previous example, your disposable income was $41,000. Let's say that you pay $12,000 in rent and $5,000 annually on food. You spend another $2,500 on utilities, $500 on clothes, $7,500 on car payments, and another $2,500 per year on gas to get to work. The sum of your necessary expenses is $30,000. 

If you subtract this from your disposable income, you have $11,000 remaining. This is the amount of money that you can use as you please. You can put it in a savings account, build an emergency or rainy day fund, invest it, use it to pay down debt or spend it on a vacation. 

There are also discretionary income calculators available online. These calculators allow you to input your fixed essential expenses so that you can determine your discretionary income. 

Why is discretionary income important?

Knowing your discretionary earnings is essential because it allows you to determine the amount of income you have leftover when building a budget. When there is a status change in your employment, your discretionary income is most affected.

Your essential expenses are rather fixed. For instance, unless you move or refinance, the monthly payment on your mortgage will always be the same. No matter if you receive a raise at work or are fired from your job, you are still going to need to make your house payment. 

On the other hand, your discretionary funds are flexible. If you receive a raise, your discretionary income can increase. Your fixed essentials remain the same as they did on your previous salary, but you now have more leftover to spend. Vice versa, if you lose your job, your discretionary income shrinks. After subtracting your essentials from emergency savings, you may not have money remaining to spend on extras. 

Do lenders consider discretionary income at all? 

Yes, lenders will consider discretionary income, but only if you have monthly student loan payments. If you are struggling with federal student loan debt, your lender may work with you to craft an income-driven repayment plan (IDR plan). 

This student loan repayment plan will cap your monthly payment at a certain percentage of your discretionary income. The caps can be: 

  • 10%

  • 15%

  • 20%

The Department of Education uses your adjusted gross income (AGI), location and family size to determine discretionary income. The repayment terms for your federal student aid are ultimately based on the poverty line in your area. 

The U.S. Department of Education offers four repayment options to student loan borrowers: 

  1. Revised Pay As You Earn (REPAYE)

  2. Pay As You Earn (PAYE)

  3. Income-Based Repayment Plan (IBR)

  4. Income-Contingent Repayment Plan (ICR)

The first three options define discretionary income as the difference between your AGI and 150% of the federal poverty guideline for your family size and state of residence. The fourth option defines discretionary income as the difference between your AGI and 100% of the poverty line. 

So, based on these plans, your monthly repayment on your federal student loan will be no more than 20% of your discretionary income. These standard repayment plans may also reduce or eliminate your interest rate. If your income is low enough, you could be granted student loan forgiveness, and your monthly payment will be $0. 

How does discretionary income relate to credit cards? 

Federal student loan servicers are required to work with borrowers to craft a repayment plan for student loans based on discretionary income, but credit card lenders are not required to do so. 

But, discretionary income can still impact your credit cards. For instance, let's say that you have $10,000 in available credit on a card, and your discretionary income is $7,000. If you max out the credit card, you will not be able to pay off $3,000 of the balance. You'll end up accumulating high-interest debt, meaning you'll need to devote more funds in the future to pay it down. 

Overspending is one of the biggest downsides to credit cards. Credit cards allow you to borrow and spend money that you don't have. 

When using a credit card, try not to spend more than you can pay off each month by keeping your expenditures below your discretionary income. 

What can you do with discretionary income if you carry debt? 

If you are looking for ways to pay down credit card debt, you could use your discretionary income to do so. Consider using a credit card payoff app like Tally. Tally helps you pay down your debt quickly and efficiently. It’ll also help you make all of your monthly payments on time, which could improve your credit score

Understanding discretionary income can help improve your personal finances 

Knowing what discretionary income is can go a long way toward improving your financial situation. At the most basic level, discretionary income is your gross income minus taxes and necessary expenses. It's different from disposable income, which is just your net income or take-home pay. 

Discretionary income can be vital if you are looking to repay student loans on an income-driven repayment plan. Using a student loan calculator and talking with your loan servicer will help you better understand your options in this regard. Discretionary income is also important for budgeting and knowing how to use credit cards responsibly. 

Using discretionary income to pay down credit card debt? Consider using Tally to save money and pay down your debt faster.