What Is (and Is Not) Considered Disposable Income
You’ve likely heard terms such as net income, gross income, adjusted gross income, take-home pay, and disposable income. But do you really know what each term means, both in definition and to your financial health? And if you don’t, how can you move forward with a realistic budget in mind? We break down what’s really considered disposable income—and what isn’t—below.
What Is Disposable Income?
Putting it simply, disposable income is the money you have left over from your salary after you’ve paid federal, state, and local taxes.
It’s also called gross income, or disposable personal income (DPI).
Disposable income also has economic significance. Not only is it one of the major determinants of consumer spending, it also is one of the 5 determinants of demand. In case you need a little Econ 101 refresher (don't we all?), demand is “how many goods and services are bought at various prices during a certain period of time.” In short, how much disposable income someone has determines (among other factors) how much money they spend on goods and services.
What Isn’t Considered Disposable Income?
But don’t spend all your disposable income just yet. Disposable income is not to be confused with discretionary income. Discretionary income takes it a step further: it’s what you have left over not only after you’ve paid federal, state and local taxes, but what you have left after necessities like rent, your mortgage payments, healthcare, transportation, and clothing.
Discretionary income can be spent on eating out, investing, travel, and any other non-essential items or expenditures. It’s your "fun money," the money you can spend on things you don’t actually need with limited guilt, knowing that your other expenses are taken care of.
How to Budget Your Disposable Income
It’s no secret that you should have a budget, and that especially applies to your disposable income.
While there are various different types of budgeting: the 50/30/20 rule, the envelope system, the 80/20 method, the traditional line item budget, even the "pay yourself first" method, it really comes down to personal circumstances and preferences when selecting which method to use. After all, there’s no point in having a budget if you aren’t going to stick to it or it's unrealistic for your current lifestyle or situation.
Some questions to consider before choosing a budget: Do you have student loans? Credit card debt? Do you like padding your savings, or would you rather invest your extra funds and only keep the bare minimum in liquid cash? Are you a spender or a saver? How often do you eat out? Do you like to travel frequently or are you more of a homebody? Do you have expensive taste or do you like to be frugal in your purchases?
Once you decide your financial priorities, then you are able to find the budget that works best for you. And when filling in your budget, don’t forget these often-overlooked budget busters.
How to Cut Disposable or Discretionary Spending
But let’s say the numbers just aren’t adding up. It may be time to reevaluate your spending habits and cut back where you can.
Try this worksheet to cut back on discretionary spending. After all, by definition, it is spending on items you could realistically do without.
Try these tips to trim your budget: combine errand trips to save money on gas, stop or limit eating out, pay off debts as soon as possible to save money on interest, buy groceries in bulk from a club store like Sam’s Club or Costco, or reduce cable bill by selecting a cheaper package. (Contrary to popular belief, you don’t need HBO.)
Some discretionary spending items you could probably cut without issue include that never-used gym membership, a biweekly manicure/pedicure or other spa treatment, magazine or live streaming subscriptions, professional societies or club dues, even holiday gifts.
Do Your Numbers Add Up?
Many experts say your necessities (rent or mortgage payment, food, taxes) should only account for 50 percent of your budget, while discretionary spending should account for 30 percent or less.
The remaining 20 percent should be used for other financial goals, such as paying off debt, saving, or investing.
While this goal may be too lofty for some, try to get as close to this number as you can. Your future self will thank you.