Discretionary income is defined as the cash you have available to spend after your necessary payments are covered. Those necessities are typically made up of basic living expenses, such as housing, utilities, food, healthcare, insurance costs, as well as minimum payments on debt.
So what does discretionary income equal in daily life? It’s the post-tax money you can put toward things like eating out, entertainment, travel, clothing, electronics, and gym memberships. You might think of discretionary income as paying for the wants in life vs. the needs.
Read on for a closer look at the meaning of discretionary income, including examples, how to calculate discretionary income, plus tips on how to make the most of your discretionary income.
Key Points
• Discretionary income is the money left after paying for necessary expenses like housing, utilities, food, healthcare, and insurance.
• Common uses for discretionary income include nonessential spending, saving/investing, and paying down debt.
• Calculating discretionary income involves subtracting necessary expenses from take-home pay.
• Your income, cost of living, debts, and tax rate all impact how much discretionary income you have.
• Effective management of discretionary income involves monitoring spending, setting goals, increasing income, and avoiding lifestyle inflation.
What Is Discretionary Income?
Discretionary income is defined as the amount of post-tax income that is left over after you have paid for all your essential expenses. Essential expenses include your mortgage or rent, utilities, car payments, as well as food, healthcare, and occasionally clothing (if it is needed, not just wanted). To phrase it another way, no, a Netflix subscription or your AM latte isn’t a “necessity.”
Also worth noting (warning, buzzkill ahead): Discretionary income isn’t just to be spent on cool stuff and fun experiences. It’s also important to put at least some of this money towards savings and making extra payments on any debt. This can help you build wealth and financial security over time.
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7 Examples of Discretionary Income and Expenses
Discretionary expenses are the things people buy with their discretionary income. Here are some examples:
Entertainment and Eating Out
This category includes such expenses as dining out, getting drinks, splurge-y takeout food (pizza delivery, we’re looking at you!), and fancy coffees. In terms of entertainment, the following is typically considered discretionary: Concert, play, and movie tickets, as well as museum admission, books, magazines, streaming services, and similar costs.
Recommended: How to Save on Streaming Services
Vacations and Travel
Taking a vacation, whether you go to the other side of the planet or an hour’s drive away, is not a necessity, despite how you may feel about it.
Luxury Items
These expenses could be anything from a pricey sports car to designer clothes to jewelry to wine. While clothing and a car may be necessities in life, when you pay extra for top-notch prestige brands, you enter the realm of discretionary expenses.
Memberships and Hobbies
Yes, joining a gym or taking up a musical instrument are admirable pursuits. But they are not essential. For this reason, things like yoga or Pilates classes, crafting supplies, and similar expenses are considered discretionary.
Personal Care
A basic haircut or bottle of shampoo may not be discretionary, but pricey blowouts, manicures, massages, skincare items, and the like are.
Upgrading Items
If your current phone is functional but you still decide to buy the latest one, that’s a discretionary expense. The same holds true for being bored with your couch and getting a new one or remodeling your bathroom just because.
Gifts
Of course you want to show you care for your loved ones. But buying presents for others isn’t something you absolutely have to do, so this should be earmarked as a discretionary expense.
How Is Discretionary Income Used?
In addition to making the types of purchases listed above, discretionary income can also be used to save for future purchases and getting ahead on long-term financial goals.
Common Uses of Discretionary Income
Here’s a more detailed look at some of the different ways you can use discretionary income:
• “Fun” spending: Many people use discretionary income to purchase goods or experiences that they can enjoy right away.
• Saving for short-term goals: Another common use of discretionary income is to put it in a high-yield savings account earmarked for goals like taking a vacation or making a down payment on your dream house.
• Paying down debt: While minimum payments on debts are generally considered necessary expenses, making extra payments is a common — and potentially smart — way to use discretionary funds.
• Investing: Another way many people use discretionary income is to invest it in the market for long-term goals like retirement or a child’s future college education.
• Charitable donations: Doing good with your discretionary dollars is another common and positive way to spend discretionary income.
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How to Calculate Discretionary Income
The formula for calculating discretionary income is:
Discretionary Income = Gross Income − Taxes − Essential Expenses
Start by assessing your average monthly take-home income (gross income − taxes). You can do this by scanning the last several months of financial statements. Or if your only source of income is your paycheck, you can simply look at your paystubs.
Next, you’ll need to tally up your essential expenses. These may include:
• Rent/mortgage payment
• Utilities
• Internet/phone bills
• Groceries
• Minimum debt payments (credit cards, student loans or car loans)
• Insurance premiums
• Medical expenses
• Transportation costs
Once you know how much you’re spending on essentials, you can subtract that number from your monthly take-home income. The result is your monthly discretionary income.
Factors That Affect Discretionary Income Calculation
A number of things can influence the amount of discretionary income you have to spend, such as:
• Income level: Higher earnings generally increase discretionary income, provided you don’t increase your living expenses as your income goes up.
• Living costs: Living in an area with a high cost of living raises essential costs and, in turn, lowers discretionary income.
• Debt level: Needing to make monthly payments on loans, credit cards, and other financial obligations reduces funds available for discretionary spending.
• Tax rates: Higher income and/or property taxes lowers your take-home pay, resulting in less discretionary income.
• Inflation: Rising prices for goods and services increases essential expenses, which shrinks discretionary income.
What Is a Good Amount of Discretionary Income?
Generally, a good amount of discretionary income means you have enough funds after covering your essential expenses to be able to save, invest, and still enjoy the pleasures of life. The 50/30/20 budgeting formula offers one way to allocate your income. It suggests using 50% of your take-home pay on needs, 30% on wants (discretionary purchases), and 20% on goals (saving and paying more than the minimum on debts).
For example, if your monthly take-home income is $5,000, $2,500 would be siphoned off for necessities, $1,500 would be allotted for wants, and $1,000 would go toward goals like saving and investing.
Managing Your Discretionary Income for Financial Success
Making the most of your discretionary income involves thoughtful planning and smart money management. Here are some strategies to consider:
• Track your spending: “It’s the last thing that many people want to do on their precious weekends, but tracking spending is essential. There is real truth to the saying ‘What gets measured gets improved,’” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. You may find some easy places to cut back, freeing up more money for saving.
• Slash necessary expenses: Consider ways you might be able to reduce the cost of essentials, such as switching to a more affordable insurance, cell phone, or internet provider; meal-planning to cut food spending; or moving to a less expensive location.
• Set financial goals: Having specific goals — like purchasing a home, funding a child’s future education, or retiring early — can help you stay focused and use your discretionary income wisely.
• Grow your income: To boost discretionary income, you might ask for a raise at work or look into side jobs, freelance work, or ways to earn passive income.
• Avoid lifestyle creep: As your income rises, try to resist the temptation to increase spending. Consider funnelling the extra funds into savings or investments to build wealth and strengthen your financial future.
Discretionary vs Disposable Income
The terms “discretionary income” and “disposable income” are often used interchangeably but they are not the same thing.
Key Differences
While discretionary and disposable income both refer to income left over after certain financial obligations are met, they differ in scope.
• Disposable income refers to the money you have left from your earnings after taxes are taken out but before any other deductions are removed. It’s the total amount you have available to spend, which is typically a much higher number than your discretionary income.
• Discretionary income is a subset of disposable income — it’s the amount of money left after your taxes and all necessary expenses are paid. You use it for “extras” like entertainment, savings, and investments.
It’s important to note that the government and courts may have slightly different definitions of these terms. In bankruptcy cases, for example “disposable income” is the amount that remains after subtracting allowed bankruptcy expenses from your monthly gross income.
If you have student loans, the federal government uses a discretionary spending formula to set your repayment amount under income-driven repayment plans. For many plans, they define “discretionary income” as the difference between your annual income and 150% of the poverty guideline for your family size and state.
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Once you know how much discretionary income you have, it’s a good idea to set some of it aside in a savings account that pays an above-average interest rate.
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FAQ
What is the meaning of discretionary income?
Discretionary income is defined as the amount of money you have left after covering essential expenses like taxes, rent or mortgage, utilities, and groceries. It represents the portion of your income that can be used for nonessential spending, such as entertainment, dining out, and vacations.
What is an example of discretionary income?
Discretionary income is the money left after paying for essentials like rent, groceries, and utilities. So, for example, if you earn $4,000 a month after taxes, spend $2,500 on necessities, and have $1,500 left, that’s your discretionary income. You could use that $1,500 for dining out, entertainment, and/or saving for a vacation. How you spend this money reflects your financial priorities and lifestyle choices.
What is the difference between discretionary and disposable income?
Disposable income is the money left after paying taxes and is used to cover both essential and nonessential expenses. Discretionary income, on the other hand, is the portion of disposable income left after covering necessities, like housing, food, and utilities. You can use this money for entertainment, shopping, or saving.
How does discretionary income impact financial planning?
Discretionary income is the money you have left after covering all of your essential expenses. It plays a key role in financial planning because it determines how much you can save, invest, and spend on nonessentials each month. Higher discretionary income gives you more flexibility in your budget, allowing you to save for emergencies and other goals, invest for future growth, and enjoy life’s pleasures.
Can discretionary income be invested?
Yes, discretionary income can be invested to grow your wealth over time. After covering essential expenses, you can allocate discretionary income to stocks, bonds, mutual funds, or retirement accounts. Investing part of your discretionary income can help you build financial security, generate passive income, and achieve long-term goals like sending a child to college or retiring comfortably.
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