What Is Discretionary Income? Understand the Basics
Understanding discretionary income can help you make the most of your money. This is especially true for students who have student loans they need to pay back. In fact, there are several federal plans for borrowers who have trouble making their payments. These income-driven repayment plans can provide some relief.
This article will help you understand discretionary income and how it relates to general budgeting and student loan repayments.
What Is Discretionary Income?
Discretionary income is the amount of money you have remaining after paying for bills and essentials like food and housing. It’s what you use for anything extra that you don’t need to live, like entertainment, vacations, debt, investments and nonessential services.
Unfortunately, discretionary income is usually the first thing to get cut from the budget when people lose their jobs or get a pay cut. So while income taxes decrease with lower pay, other essential bills like food and housing don’t.
Did You Know?
There’s a difference between discretionary income and disposable income, although they may sound the same. Disposable income is the amount of money left over after paying federal, state and local income taxes. The government tracks this metric as a key macroeconomic indicator of the overall state of the economy.
How Is Discretionary Income Used?
Here are two ways that understanding discretionary income is essential in achieving your financial goals.
General Budgeting
One of the most important things to do to ensure personal financial success is to track your income and expenses. Having a budget might sound scary, but it’s a proven tool to make sure your money does what you want.
One way to understand how discretionary income fits into any budget is by using what’s known as the “50/20/30 rule.” Senator Elizabeth Warren popularized this approach to budgeting. The rule simply divides up your after-tax income into the following three categories:
- 50% on essential needs
- 30% on wants
- 20% on savings goals
In this scheme, both the 30% on wants and the 20% on savings would be considered discretionary income.
Student Loan Payments
Outstanding student loan debt has climbed to over $1.7 trillion. While President Joe Biden and his administration are considering canceling some student debt, it’s still a painful reality for many students.
If you’re having trouble paying your student debt, there are several federal plans you should know about. You might be able to enroll in an income-driven repayment plan, which considers your discretionary income. Here are four plans to consider:
- Income-based repayment
- Income-contingent repayment
- Pay As You Earn (PAYE)
- Revised Pay As You Earn (REPAYE)
Each of the plans has various income qualifications compared with the federal poverty guidelines. For example, the income-based repayment plan defines discretionary income as the difference between your annual income and 150% of the federal poverty guideline.
Key Takeaways
- Discretionary income is the amount of money you have after paying your taxes and essential expenses like food and housing.
- It’s a vital part of maintaining a budget to make sure you achieve your financial goals.
- For those with student loans, there are income-driven repayment plans that take your discretionary income into account.
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- U.S. Bureau of Economic Analysis. "Disposable Personal Income."
- CNBC. 2021. "Student Loan Forgiveness Would Benefit These Groups the Most."
- CNBC. 2021. "Student Loan Forgiveness May Be on the Way. What To Do in the Meantime."
- Forbes. 2020. "Discretionary Income: How It Could Impact Student Loan Payments."
- Forbes. 2020. "Income-Based Repayment: What It Is, How To Apply."
- Forbes. 2020. "Guide to Income-Contingent Repayment."
- Forbes. 2020. "Guide to Revised Pay As You Earn."
- Office of the Assistant Secretary for Planning and Evaluation. 2021. "2021 Poverty Guidelines."
