Dissecting Discretionary Income: Understanding, Computation, and an Example
Define discretionary income, learn how to calculate it, and explore an example to grasp its significance in financial planning.
Discretionary income is a financial term used to describe the amount of money an individual or household has left over after covering essential expenses like housing, food, utilities, transportation, and insurance. It represents the income that can be used for non-essential or discretionary spending, such as entertainment, vacations, savings, and investments. Understanding, computing, and analyzing discretionary income can be crucial for financial planning and budgeting. Here's how you can dissect discretionary income:
Understanding Discretionary Income:
Discretionary income is a measure of a person's or family's financial flexibility. It's the money available for saving, investing, and spending on non-essential items. This income can vary greatly depending on a person's financial situation, including their income, expenses, debt, and financial goals.
Computation of Discretionary Income:
To compute discretionary income, you need to follow these steps:
a. Calculate Gross Income: Start by determining your gross income, which includes your total earnings before taxes and other deductions. This can come from your salary, wages, self-employment income, and any other sources of income.
b. Deduct Taxes: Subtract all applicable taxes, including federal, state, and local income taxes. The resulting figure is your net income.
c. Subtract Essential Expenses: Deduct all necessary expenses that are essential for your daily living, such as rent or mortgage, utilities, groceries, transportation costs, insurance premiums, and any other non-discretionary spending.
d. Subtract Debt Payments: Subtract any mandatory debt payments, such as student loans, car loans, credit card minimum payments, and personal loans.
The remaining amount after all these deductions is your discretionary income.
Example of Discretionary Income:
Let's illustrate this concept with an example:
- Gross Income: $60,000 per year
- Taxes (federal, state, and local): $10,000 per year
- Essential Expenses (rent, utilities, groceries, transportation, insurance): $30,000 per year
- Debt Payments (student loan and credit card minimum payments): $5,000 per year
To calculate discretionary income:
- Gross Income - Taxes = $60,000 - $10,000 = $50,000
- $50,000 - Essential Expenses = $50,000 - $30,000 = $20,000
- $20,000 - Debt Payments = $20,000 - $5,000 = $15,000
In this example, the discretionary income is $15,000 per year. This is the amount available for non-essential spending, saving, and investing.
Discretionary income is a valuable metric for budgeting and making financial decisions. It helps individuals and families understand how much they have available for discretionary spending and achieving their financial goals. Analyzing discretionary income can guide choices about saving for retirement, building an emergency fund, or enjoying leisure activities without straining your finances.
What Is Discretionary Income? How to Calculate, With Example.
Discretionary income is the money you have left over after paying for your essential expenses, such as housing, food, and transportation. It is the money that you can spend on whatever you want, such as entertainment, travel, or savings.
To calculate your discretionary income, simply subtract your essential expenses from your total income. For example, if your total income is $50,000 and your essential expenses are $30,000, then your discretionary income is $20,000.
Here is an example of how to calculate discretionary income:
Total income: $50,000Essential expenses:
- Housing: $15,000
- Food: $5,000
- Transportation: $5,000
- Other essential expenses: $5,000Total essential expenses: $30,000Discretionary income: $50,000 - $30,000 = $20,000
Discretionary income is an important metric to track because it can give you an idea of how much money you have available to save, invest, or spend on non-essential expenses. It can also help you to budget and make informed financial decisions.
Here are some tips for increasing your discretionary income:
- Increase your income. This could involve getting a raise at your current job, starting a side hustle, or finding a new job that pays more.
- Reduce your expenses. Take a close look at your budget and see where you can cut back on unnecessary expenses. For example, you could eat out less, cancel unused subscriptions, or find cheaper alternatives to your favorite products.
- Automate your savings. Set up a recurring transfer from your checking account to your savings account each month. This way, you will save money without even having to think about it.
- Live below your means. Avoid spending more money than you earn.
By increasing your discretionary income, you can improve your financial situation and reach your financial goals.