Discretionary income: Definition, how to calculate it and how it impacts your budget
What is discretionary income?
Discretionary income is the amount of money remaining after you pay essential bills such as your mortgage or rent, groceries, utilities and other necessary expenses.
How to calculate discretionary income
To start, add your after-tax income for the month, which can include your job, tips, the income you make from side hustles and other revenue streams.
Next, add up all of your necessary expenses and then subtract that total from your earnings to give you your discretionary income. Say, for example, your disposable income (the amount you earn after taxes) is $3,000 per month. You pay $2,250 per month in necessities. Your monthly discretionary income would be $750.
How discretionary income impacts your budget
Discretionary income can be a barometer of how well your finances are going. If you have a healthy balance after your necessities, you can use a portion of this to invest, save money, and have “fun” money for such expenses as travel, streaming services and entertainment. If, however, you have minimal discretionary income, it means you need to retool your expenses.
To further cut expenses or reduce other spending, consider revisiting your budget or creating one if you don’t already use one. Also, a budgeting app can help give you a fresh perspective on how you spend your money.
You can also sign up for Bankrate’s myMoney to categorize your spending transactions, identify ways to cut back and improve your financial health.
Discretionary income and income-driven repayment plans for student loans
If you have student loans, there are income-based repayment plans you can use that cap your payments at a specified percentage of your discretionary income. And if you’re not earning much income, you can qualify for zero-dollar payments that count toward your repayment term.
The U.S. Department of Education has a loan simulator tool you can use when determining the amount of your loan payments.
Other income-repayment solutions include:
- Pay As You Earn Repayment Plan (PAYE): With this option, you have a 20-year repayment term, where you allocate about 10 percent of your annual discretionary income, divided into 12 monthly payments.
- Revised Pay As You Earn Repayment Plan (REPAYE): In this plan, you also pay about 10 percent of your annual discretionary income divided into 12 monthly payments, but your repayment term varies. For undergraduates, it’s 20 years, while graduate students get 25 years.
- Income-Based Repayment Plan (IBR): You pay up to 15 percent of your annual discretionary income which is also divided into 12 monthly payments. If you are a new borrower, your payment will be 10 percent of your annual discretionary income divided by 12. Your repayment period is between 20 years (if you’re a new borrower after July 1, 2014) and 25 years (if you have outstanding loans before July 1, 2014.)
- Income-Contingent Repayment Plan (ICR): For this option, you pay either 20 percent of your annual discretionary income (divided into 12 monthly payments) or what you would pay monthly under a 12-year repayment term, adjusted by how much you earn. Repayment terms under this option are up to 25 years.
One of the benefits of income-based repayment plans is that if you make timely payments throughout your repayment term, the government can forgive any balance remaining after the repayment period ends. However, it should be noted that the forgiven amount may be considered taxable income. If you encounter an economic hardship, the government offers programs to keep your loan current while lowering or deferring repayment.
The government calculates your discretionary income by subtracting 150 percent of the poverty guideline for your state and household size from your annual income. For Income-Contingent Repayment Plans, it’s 100 percent of the poverty guideline. The U.S. Department of Health and Human Services provides a detailed breakdown of poverty guidelines for 2021.
You must also recertify your income and family size with your loan servicer annually. They will send an income-driven repayment application for you to complete.
Discretionary income vs. disposable income
There is a distinction between discretionary and disposable income:
- Disposable income is the money you have available to spend after your employer withholds taxes from your paycheck. It doesn’t account for any necessary bills you have like rent or car payments.
- Discretionary income is your remaining money available after subtracting necessary bills from your income.