When it comes to financial security, there are a lot of terms used to identify where you’re currently standing. From staying on track for retirement to understanding your debt-to-income ratio, one common term is discretionary income.
What exactly is discretionary income?
While income is what you use to pay for expenses, savings, retirement, and daily spending, discretionary income falls into a unique category. Often confused with disposable income, discretionary income is very important to your long-term financial success.
Keep reading to understand what discretionary income is and how you can use it to your advantage.
Defining Discretionary Income
To begin, what is the definition of discretionary income? This is the money you have remaining after you’ve paid taxes and other cost-of-living expenses (rent, transportation, etc). It’s known as discretionary income because you can use it at your discretion. In other words, you can decide how to use these funds, whether that means saving it for a rainy day, investing in stocks, or dining out.
You can think of discretionary income as any money you use for things that are nice to have but aren’t necessary to live. For example, it’s nice to splurge on movie tickets on a Friday night, but you’ll be fine without them. Similarly, it’s helpful to pay down your debt by making a larger payment, but this isn’t required to stay afloat financially. We can break discretionary income into 3 main categories:
- Spending: You can spend discretionary income on non-essentials like travel, luxury dining, clothing, loan repayment, services, and more.
- Investing: Discretionary income can also be invested back into the economy. You might purchase stocks, build businesses, and so on.
- Saving: Putting your money aside for long-term savings is also a way to use discretionary income. Significant household savings are a sign of greater discretionary income.
As you can see, discretionary income is a sign of your economic stability. As your income grows, so does your discretionary income. You can also invest time in a side hustle, investing, and more to see your discretionary income develop further.
Discretionary Income vs. Disposable Income
Often, you’ll hear the terms discretionary income and disposable income used interchangeably. Though commonly used in place of each other, these terms have distinct definitions. Disposable income is the income used to pay for expenses and essentials after taxes.
On the other hand, discretionary income is money left after your essential expenses. Your personal income minus your personal taxes is your discretionary income. Once you’ve paid essential cost-of-living expenses, you’ll be left with your discretionary income. With this understanding, your discretionary income will always be less than your disposable income. Both numbers are an important piece of the financial wellness formula.
How to Calculate Your Discretionary Income
Did you know you can calculate your discretionary income yourself? This number is an important way to check in with your financial security, and it might also help you prioritise your spending. For some types of loan repayment, you’ll actually need to know your discretionary income. Here’s how to easily calculate this number:
- Take your personal income (minus taxes)
- Subtract all expenses (rent, essential groceries, utilities)
- The result is your discretionary income
For example, if you take home $50,000 a year after taxes and your average expenses annually come out to $30,000, you have $20,000 in discretionary income. This is money you can spend as you please, whether that means having fun, investing, or saving.
If you discover you only have a marginal discretionary income, this can be a sign that something needs to change. You might need to check in with your current budget to see if you can cut your current expenses.
Keep in mind that your discretionary income isn’t set in stone. It can change depending on your situation. Here are some reasons your discretionary income might need to be recalculated:
- Your employment status changed
- Your family grew or your marital status changed
- You’ve moved to a different cost-of-living area
- You’ve paid down debt and have fewer expenses
Knowing how to calculate your discretionary income makes it easier to stay on top of your financial goals. Financial fluctuation is a part of life. Being prepared for these unavoidable ups and downs makes all the difference. You need to know how much “pocket money” you have to spend regularly. When you prioritise your most important goals first, it’s easy for this income to be put to work for you.
In Summary: Understanding Discretionary Income
As you now know, discretionary income is the amount of income you have remaining after taxes and necessary expenses. This is an important part of your budget, and it helps you determine how much wiggle room you have for fun, saving, and investing. Your discretionary income can also impact your specific loan repayment amount, especially for student loans.
Do you need help understanding your current spending? It’s normal to run into financial questions, especially if you’re fixing up your budget for the first time in a while.
Don’t hesitate to reach out to the expert-driven team at Debt Busters. With experience helping Aussies navigate financial wellness for over a decade, we’re on your side every step of the way. Contact us today on 1300 368 322.