What is Discretionary Income?

Managing personal finances can be a challenging task, especially when unexpected life events force you to reevaluate your financial situation. Sudden job changes, unforeseen accidents, or planned adjustments can all necessitate a thorough revision of household budgets. During this process of reassessing needs, wants, and spending priorities, you may encounter the critical concept of discretionary income. 

The good news is that learning how to use your discretionary income can help you to navigate financially challenging times, be it now or in the future.   

But what exactly is discretionary income, and how do you figure yours out?

Discretionary income is the amount of your income, or your household’s, that’s left over to spend, invest, or save after taxes and after spending on necessities.¹ Generally speaking, necessities are taxes, food, shelter, and clothing. “Discretionary spending” is the term more often used in everyday conversations, but it’s derived from your discretionary income. Discretionary spending is a cost for something that is not essential to you personally or to your household,² like little and big luxuries, vacations, and entertainment. Put simply, it’s the flipside of necessity/needs.

There’s a lot going on in there, so understanding what discretionary income means for you and your household might require close scrutiny. For example, what you – or others in your household – deem as “necessities” can prompt debate and disagreement. But to get to the basics, necessities are needs and obligations that you must pay for at monthly or regular intervals.

The terms “disposable income” and “discretionary income” often get used interchangeably, but they’re actually two very different things. Disposable income is the amount you have left to spend or save after paying taxes.³ Often called your “take-home pay,” disposable income is what you have in hand, in a paycheck, or directly deposited, after federal, state, and/or local/municipal taxes are subtracted.

Your disposable income can also be affected by benefits like retirement account contributions, health insurance, and others.⁴ Experts note that disposable income can reflect several sources, such as: salary, freelance work, retirement benefits, Social Security, dividends, rental income, and child support.⁵

Discretionary income, on the other hand, is the portion of your disposable income left over after you pay for your necessities.

To figure out your discretionary income, a simple calculation might look like this: Discretionary Income = Disposable Income – Necessary Expenses.

Since your discretionary income depends on your needs – and necessities lists can be extensive – everybody’s calculation is different. For example, if you need a car, you’ll also need to pay for car insurance, registration, repair, and gas expenses. A house can mean mortgage, insurance, utilities, and upkeep. Rent can mean rent, rental insurance, and maybe even parking fees. Food ranges from everyday groceries to birthday and anniversary dinners out. Some list healthcare insurance under necessities, and many college grads include student loan repayment obligations.

As you can see, these “necessities” change a lot depending on your personal circumstances.

Discretionary income can be affected by changes in salary, jobs, and tax rates. A pay cut, whether at your current employer or a new job with a lower starting salary, would likely affect discretionary income, meaning you might have to refocus your budget on necessities.

Global factors and federal policies can also impact individual and household economics. When the economy is strong , you may have higher discretionary income. But during time of inflation , discretionary income and spending may decline as prices on necessities increase. Since a combination of personal and external factors can affect your discretionary income, it’s important to be vigilant and maintain your budget as needed.