Disposable Income vs Discretionary Income

There is often a great disparity between the money you earn and the money you have, and the more you earn, the greater that disparity becomes. If you’re self-employed, have a large family or pay a lot of tax, that disparity becomes even bigger. That’s where disposable income and discretionary income come in.

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In this guide, we’ll look at the differences between disposable income and discretionary income and show you where and how the two calculations are used.

Gross Income

Before we look at your disposable and discretionary income, we need to look at your gross income. All calculations begin with this amount and every employee should know what their gross income is.

If you earn $20 an hour and work 40 hours a week then your gross income is $800 a week.
You do not deduct taxes, expenses or anything else from this sum. The same applies if you are self-employed, in which case your gross income will be the sum you generate before expenses and other costs are deducted.

The situation is a little trickier for self-employed workers, because the gross income isn’t necessarily the amount they pay tax on. However, in both cases, gross income refers to full income or “take home pay” before any deductions are calculated.

What is Disposable Income?

Disposable income is the money that you, or your household, has to spend, save or invest after taxes have been accounted for. To calculate your disposable income, simply subtract your income taxes from your gross income.

For example, if you earn $100,000 a year and pay a 24% rate of tax then your gross income is $100,000, your taxes are $24,000, and your disposable income is $76,000.

Where is Disposable Income Used?

Disposable income is used to determine the health of the economy. The more disposable income a household has, the more likely they are to make purchases and pump that money back into the economy. 

This calculation is also used by statisticians to set personal savings rates, as well as marginal propensity to save (MPS) and marginal propensity to consume (MPC). It’s not as useful to the individual as discretionary income and, in most cases, they will already have an idea of what their disposable income is. 

Wage Garnishment Disposable Income

The disposable income calculation is also used by the federal government for wage garnishment purposes, which can be ordered for the payment of child support, back taxes, and other debts. In such cases, the government uses disposable income as a base calculation and then deducts health insurance payments and retirement plan contributions.

What is Discretionary Income?

Discretionary income provides more of a realistic calculation than disposable income. After all, families and individuals don’t just have to account for taxes. They have to factor rent, food, clothing, and other services into the equation. 

Discretionary income can actually be calculated from your disposable income simply by taking the latter calculation and subtracting your expenses.

If we do this with the previous calculation of $76,000 after tax and assume the following expenses, then the discretionary income is $30,000:

  • Rent: $16,000
  • Food: $5,000
  • Transportation: $10,000
  • Clothing: $10,000
  • Insurance: $5,000

Your “necessities” are the things that you need to purchase to keep your family healthy, fed, and clothed. It does not include things such as computers, media subscriptions, and other luxuries, but it does include the money you spend to eat, get to work, and pay insurance premiums.

Of course, if you’re a self-employed writer, artist or other professional then computers will be included, but their inclusion will come during the disposable income calculation. They are expenses, so they are deducted before your tax is calculated. This is why many self-employed individuals have such low disposable incomes when compared to salaried workers with a similar gross income.

Where is Discretionary Income Used?

Discretionary income is a more useful indicator of the health of the economy than disposable income. It is also used to calculate whether an individual qualifies for financial aid, such as the income-driven repayment schemes offered on federal student loans.

It’s good thing to know for individuals and families, as well.
Understanding your discretionary income can help you to better understand your finances and keep them under control.

After calculating their discretionary income, many debtors discover they are spending money they simply don’t have. If you have a high disposable income, it’s easy to assume you have plenty of cash and can spend relatively freely. But unless this is confirmed by your discretionary income you need to stop spending and work on increasing your income or decreasing your expenses.

What are the Averages?

We mentioned that both disposable income and discretionary income are used to calculate the health of the economy, so what are the averages, what figures should you be comparing your calculations to?

In the US, the average monthly disposable income is $3,500, which is one of the highest in the world. Switzerland is one of the few countries higher than the United States, as residents there earn an average in excess of $6,300 a month. The US average is also slightly higher than Canada’s, but it’s worth noting that these figures differ considerably from state to state.

In some of the richer states, the disposable income is double what it is in the poor states, with D.C., averaging one of the highest and Mississippi one of the lowest.

Discretionary income is much lower, on average. In fact, the average US household has just $1,700 left over every month after accounting for taxes and other expenses. What’s more, this is the mean average, which means it’s inflated by the highest earners. The average family earning less than $80,000 a year has much less money left over every month and in many cases, once those necessities have been covered, only debt and demands remain.

Summary: Disposable Income vs Discretionary Income

To summarize, there are several ways of calculating your income to arrive at figures that you, your lenders, and statisticians use to determine how stable your finances are. It all begins with your gross income, which is the total money you earn every month/year. From this, you deduct your taxes to arrive at your disposable income and then deduct your necessary expenses to arrive at your discretionary income.