Since discretionary income reflects everything we have to spend after taking care of necessary expenses, there has never been a more relevant time to familiarise ourselves with the term than right now. If you’ve found yourself drowsy – thanks to the mess that’s our economy – after sensing the looming thunder of another recession after a long spell of stagnation, understanding how discretionary income works will shed light on whether your paycheck can cover your payments, and will help you keep tabs on your comfort level when considering your changing lifestyle and your financial health.
What is Discretionary Income?
Discretionary income is the money you have left after tax and the essentials of living (housing, food, basic utilities). What’s left is yours to spend on wants rather than needs, to invest for the future, or to save for a rainy day.
Key Points:
Discretionary income is used for non-essential purchases like entertainment, vacations, or luxury items.
It’s considered an important indicator of economic health and consumer spending power.
The amount of discretionary income can fluctuate based on economic conditions and personal circumstances.
Discretionary vs. Disposable Income: Understanding the Difference
While often confused, discretionary and disposable income are distinct concepts:
Disposable Income: Total take-home income. Your total after-tax income that you have left after paying all your personal or family expenses. You have to have enough margain after this to pay for essentials as well as luxuries.
Discretionary Income: This is what’s left of your disposable income after paying for necessities.
So, if I earn $4,000 a month on a take-home salary, and I need $2,500 of that for shelter and groceries, etcable income of $1,500.
The Economic Impact of Discretionary Income
Discretionary expenditure, which is money spent on things other than necessities, is a major driver of economic activity. The greater discretionary income, the higher the amount spent on non-essential consumer goods which, in turn, translates into an increase in gross domestic product (GDP). Conversely, when discretionary income goes down the first companies to suffer are usually players in the luxury and discretionary ‘non-essential’ sectors.
Recent Trends:
Incidence levels of discretionary personal income were also markedly affected by the coronavirus (COVID-19) pandemic. The personal savings rate in the US in 2020 hit peak levels due to lockdowns narrowing the scope of expenditures.
By 2024, this trend reduces the personal savings rate to a highly normal level – 3.4 per cent – as the post-pandemic consumer returns to previous habits.
Calculating Your Discretionary Income
To determine your discretionary income:
Start with your after-tax income (disposable income)
Subtract all necessary expenses (housing, food, utilities, debt payments, etc.)
The remaining amount is your discretionary income
Financial advisors often counselling you to try to make between 10 and 30 per cent of your net pay into discretionary income, while the iconic 50-30-20 household budgeting rule claims you should spend 50 per cent of your pay on needs, 30 per cent on wants (discretionary), and 20 per cent on savings or debt repayment.
Discretionary Income and Student Loans
Olivieri reminds me that, when it comes to federal student loan repayment plans, the government uses a different lookback, calculating discretionary income as your after-tax annual income minus 100 per cent to 225 per cent of the federal poverty line, depending on your repayment plan and family size.
Maximizing Your Discretionary Income
To increase your discretionary income:
Review and reduce unnecessary expenses
Seek ways to increase your income through side hustles or career advancement
Refinance high-interest debt to lower monthly payments
Look for more affordable options for essential expenses
The Bottom Line
Discretionary income is the difference between take-home income and essentials. This is where you allocate the resources to balance your assets and liabilities. It can also help you to achieve both growth and new adventures. But, it is often the most challenging part of your budget, as you must decide whether to give in to every perceived need or want. Does spending X amount of yuan for the newest tablet computer boost your self-esteem enough to balance the pain of taking on a new obligation?
Could it be an investment into a more rewarding profession? Could you cook yourself an authentic all-Chinese pizza for under 10 yuan? Figure out what is critical for your life by identifying your ‘core’ needs versus your ‘wants’, and establish your own discretionary balance to achieve the financial life you desire. If you actually see your most desired dreams and desires, then you can create a long-term reality that will open up the door to freedom that you could never even imagine.
Looking ahead to 2024 and beyond, tracking your discretionary income can help you assess economic uncertainties and invest your resources in ways that help keep you healthy financially. Remember, it’s not how much you earn; it’s whether you know how to spend wisely what you have.
