What Is Disposable Income Definition and Examples

If you have money left over after paying your taxes, congratulations! You have â€Å"disposable income.† But don’t go on a spending spree yet. Just because you have disposable income does not mean you also have â€Å"discretionary income.† Of all the terms in personal finance and budgeting, these are two of the most important. Understanding what disposable income and discretionary income are and how they differ is the key to creating and living comfortably within a manageable budget. Key Takeaways: Discretionary Invome Disposable income is the amount of money you have left over from your total annual income after paying federal, state, and local taxes. Discretionary income is the amount of you have left over after paying all taxes and paying for all necessities of life like housing, healthcare, and clothing. Discretionary income can either be saved or spent on non-essential things like travel and entertainment. Levels of disposable and discretionary income are key indicators of the health of a nation’s economy. Disposable Income Definition Disposable income, also known as disposable personal income (DPI) or net pay, is the amount of money you have left over from your total annual income after paying all direct federal, state, and local taxes. For example, a family with an annual household income of $90,000 that pays $20,000 in taxes has a net disposable income of $70,000 ($90,000 - $20,000). Economists use disposable income to identify nationwide trends in households’ savings and spending habits. The average disposable personal income (DPI) in the United States is about $44,000 per household, according to the international Organisation for Economic Co-operation and Development (OECD). The DPI in the U.S is far higher than the average of $31,000 among the 36 nations surveyed by the OECD. It should be noted that indirect taxes, such as sales taxes and value-added taxes (VATs) are not used in calculating disposable income. While they do generally reduce effective spending power, they are extremely difficult for individuals to track. Apart from personal finances, disposable income is also important to the national economy. For example, the United States federal government uses it to measure consumer spending and the all-important Consumer Price Index (CPI)—the average nationwide price of various goods and services. As a key indicator of inflation, deflation or stagflation, the CPI is a critical measure of the health of the nation’s economy. Disposable Income vs. Discretionary Income Just because you have money left after paying taxes, be very careful how fast you spend it. Disposable income must not be confused with discretionary income, and disregarding the difference between the two can make or break your budget. Discretionary income is the amount of money you have left over from your total annual income after paying all taxes and after paying for necessities like rent, mortgage payments, healthcare, food, clothing, and transportation. In other words, discretionary income is disposable income minus the unavoidable costs of living. For example, the same family that had $70,000 in disposable income left after paying $20,000 of taxes on its $90,000 of gross income also had to pay: $20,000 for rent;$10,000 for groceries and healthcare;$5,000 for utilities;$5,000 for clothing; and$5,000 for car loan payments, fuel, fees, and maintenance As a result, the family paid a total of $45,000 on necessities, leaving them with only $25,000 ($70,000 - $45,000) in discretionary income. In general, families or individuals can do two things with discretionary income: save it or spend it. Sometimes called â€Å"mad money,† discretionary income can be spent on all the things you might want, but not really need for anything other than â€Å"keeping up with the Joneses,† perhaps. Discretionary income is typically spent on things like eating out, travel, boats, RVs, investments, and thousands of other things we really could â€Å"live without.† The general rule is that within the same household, disposable income should always be higher than discretionary income because the cost of necessary items has not yet been subtracted from the amount of disposable income. According to the consumer credit reporting agency Experian, the average American family spends about 28% of its total pretax income—more than $12,000 per year—on discretionary items. The Tight Bottom Line   According to the U.S. Census Bureau, the average American household brought in nearly $75,000 before taxes in 2016 but ended up spending most of it. In fact, after subtracting all the money it pays in taxes, necessary good and services, and discretionary purchases, the average U.S. household spends more than 90% of its income. After subtracting all taxes and other expenditures from its $74,664 annual pretax income, the average American household has $6,863 left over. However, since interest paid on consumer debts such as credit cards and car loans are not subtracted from pretax income, the amount of money the average household has left for savings or discretionary spending is typically far lower than this. So, be careful with the plastic. Sources and Further Reading Disposable Income (2018). Investopedia.comDiscretionary Income (2018). Investopedia.comHousehold Income: 2017. U.S. Census BureauOECD Better Life Index. Organisation for Economic Co-operation and DevelopmentConsumer Spending Data. Experian.comPatoka, Josh. How to Optimize Your Disposable Income and What Should You Do With It? The Finance Genie