Definition
Discretionary income is the amount of an individual’s income that remains after deduction of all personal living expenses and financial obligations such as rent, bills, groceries, taxes, and loan repayments. In other words, it is the income left over for spending, investing, or saving after paying for necessities. It often gets channeled towards non-essential goods and services, such as vacations or luxury items.
Key Takeaways
- Discretionary income refers to the amount of personal income left after an individual has paid all their necessary expenses such as food, shelter, clothing, taxes, and loans. It is the money that individuals can spend or save as they wish.
- The level of discretionary income can greatly impact the overall state of the economy as consumers with high discretionary income are more likely to spend and invest, stimulating economic growth. Conversely, consumers with less discretionary income may spend less, potentially slowing economic growth.
- Understanding discretionary income is crucial for businesses in their strategic planning and marketing efforts, because it helps in targeting the right customers or market segments. It’s also used by lenders and creditors to determine an individual’s ability to repay a loan.
Importance
Discretionary income is vital in the financial sector as it serves as a crucial indicator of the consumer’s purchasing power, saving ability, and overall economic status.
It is the portion of an individual’s income that is left for spending, investing, or saving after paying taxes and basic necessities such as food, housing, and clothing.
Understanding discretionary income provides valuable insights into an individual’s financial health and spending habits.
Moreover, this figure helps financial advisors or planners develop a strategic budgeting plan or financial model tailored to the individual’s lifestyle and priorities.
Also, from a broader perspective, high levels of discretionary income in an economy suggest more consumer spending, which can stimulate economic growth.
Explanation
The purpose of discretionary income primarily revolves around an individual’s personal financial planning and budgeting. Its main use is to understand and manage personal finances more effectively by separating essential and non-essential expenses.
This income serves as the portion of one’s earnings available to be spent or saved at their discretion after all obligatory expenses have been taken care of. Discretionary income provides an insight into how much of the earned income can be allocated for entertainment, leisure activities, luxury goods, investments or savings, debt repayment, or any other optional, non-essential purchases.
The concept of discretionary income also plays a significant role at the aggregate level where it is used for measuring the overall health of the economy. Economists and policy-makers use this income level as an economic indicator to gauge household spending tendencies which in turn provides a perspective of the economy’s consumption capability.
A higher level of discretionary income typically indicates a robust economy as it signifies higher potential consumer spending, which stimulates economic growth. Thus, it serves not only as a personal finance tool but also a macroeconomic barometer.
Examples of Discretionary Income
Barry works as a software engineer and earns an annual salary of $80,After paying for his rent, utilities, taxes, groceries, student loan payment, and health insurance, he has $20,000 left in the bank. This is his discretionary income, which he can use for travel, savings, or other leisure activities.
Sarah is a teacher and her annual salary is $50,After deducting her regular expenses like rent, groceries, insurance and taxes, she has $7,000 left. That is her discretionary income and she opts to use it to join a gym, donate to her favorite charity, and save for a new car.
Angela, a single mother earns an annual salary of $30,After paying her fixed expenses like rent, childcare, food, and transportation, she has about $3,000 left as her discretionary income. Angela can decide to use this money to buy new clothes for her and her child, take a vacation, or save for emergencies.
FAQs about Discretionary Income
What is Discretionary Income?
Discretionary income refers to the money that an individual or household has left over after paying for their necessary expenses such as rent, groceries, utilities, health insurance, and taxes. This income can be used for luxury items, personal satisfaction, or investments.
How is Discretionary Income calculated?
Discretionary income is calculated by subtracting all the necessary expenses from the after-tax income. The resulting amount reflects what can be used for discretionary spending, such as vacations, luxury items or saving and investments.
Does Discretionary Income affect credit score?
Indirectly, yes. While discretionary income itself isn’t a factor in credit scores, managing it wisely can potentially lead to better credit scores. For instance, regularly paying off credit card balances with discretionary income can positively affect your credit score.
What’s the difference between Discretionary Income and Disposable Income?
Disposable income and discretionary income are similar, but not identical. Disposable income refers to the money that’s left after taxes have been deducted from a person’s earnings. Discretionary income goes a step further by subtracting necessary basic living costs from the disposable income to see how much is left for non-essential expenses.
Related Entrepreneurship Terms
- Disposable Income
- Consumer Spending
- Personal Savings
- Non-Discretionary Expenses
- Income Tax
Sources for More Information
- Investopedia – An exhaustive resource for all finance and investment-related terms and concepts.
- NerdWallet – Offers expert information on personal finance, including discretionary income.
- Bankrate – A reliable source that provides in-depth data and knowledge on finance and banking terms.
- The Balance – A complex and easy-to-understand resource on personal finance and money management.
