What Is Disposable Income? Understand and Better Plan Your Finances

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Disposable income is sometimes referred to as disposable personal income, net pay or take-home pay. It’s an important economic indicator for the country. It also is the foundation of your budget — the starting point for how you decide to spend your money.

If you want to be a better budgeter, you’ll need to brush up on some budgeting terms. In addition to salary, net income and gross income, you should know the terms disposable income and the acronym DPI.

But how much do you really know about how disposable income applies to your financial life? Read on to find out what disposable income consists of and how you can leverage it to better manage your finances.

What Does Disposable Income Consist Of?

Disposable income equals your income minus FICA taxes and deductions. A multitude of factors help measure disposable income, including personal income, taxes and consumption and expenditures and savings. Here’s how you can determine your disposable personal income:

Your employer may deduct other items, such as health insurance premiums, from your paycheck. Those deductions are part of your disposable income — even though you never see that money in your paycheck.

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To economists, disposable income and consumption represent the health of the economy. Consumers buy more when disposable income increases. Strong consumer spending is often a sign that the economy is functioning properly.

What Is the Difference Between Disposable Income and Discretionary Income?

The terms disposable income and discretionary income are not interchangeable. Important distinctions exist between the two. Here’s more.

Disposable Income

Disposable income is defined as the amount of money you have left after paying taxes. This is money you use to pay for essential expenses (things you need):

For example, you earn $1,000 per week, and you have $923.50 after subtracting 7.65% for payroll taxes. Your disposable income is $923.50.

Discretionary Income

Discretionary income is the amount of money you have left after you pay taxes and essential expenses. You use this money for nonessential spending, or things you want, including:

Let’s say your essential expenses are equal to 50% of your disposable income. Using the previous example, you have $461.75 each week to spend as discretionary income.

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The money you spend on essential and discretionary expenses is your consumption. Disposable income minus consumption equals savings.

What Is the Average Disposable Income in the US?

If you’re wondering if you have a good disposable income, it’s helpful to refer to the national average. The disposable income average for Americans was $49,673 in 2019, according to Federal Reserve Economic Data. This number is greater than the previous year’s disposable income of $48,233.

Disposable Income Budgeting

A budget puts you in control of your disposable income and helps you make financial decisions. It forces you to take a closer look at how you’re spending your money.

Experiment with different budgeting methods until you find the one that works best for you. Here are a few popular ideas for budgeting:

Budgeting Ideas

  • 50/30/20: Divide your disposable income into percentages for each spending category: 50% for what you need, 30% for what you want and 20% for savings and paying down debt.
  • Line-item budget: Group your expenses into categories and assign a dollar amount to each group. Money left over at the end of the month can be carried over to the same category next month.
  • Zero-based budget: This is similar to a line-item budget, but no money is left over at the end of the month. Every dollar is assigned to a category in the budget.
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Minimizing Expenses

If your expenses are greater than your income, you have two options: Find ways to earn more money or cut back on expenses. In some cases, you can cut back without making drastic changes to your lifestyle. Here are some ways to minimize your expenses.

Disposable Income

Essential expenses, such as living expenses, are necessary, but that doesn’t mean you can’t cut back in this category. Here are some ways to save:

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Discretionary Income

Many people find it easier to trim their budget by reducing discretionary expenses. Here are ideas for cutting back nonessential spending:

Armed with the knowledge of the disposable income definition and other important budgeting terms, you can take a closer look at how you’re spending your money.