Discretionary Income

Definition

Discretionary income refers to the amount of income that an individual or household has left after paying for necessities such as taxes, utilities, food, transportation, housing, and health care. It is the money available for spending on non-essentials or saving after meeting all basic needs. Essentially, discretionary income is the income available for personal hobbies, travel, luxury items, investment, or retirement fund contributions.

Phonetic

The phonetic transcription of the keyword “Discretionary Income” is /dɪˌskrɛʃəˈnɛri ˈɪnkʌm/.

Key Takeaways

1. Definition: Discretionary income is the amount of an individual’s income that is left for spending, investing or saving after paying taxes and paying for personal necessities, such as food, shelter, and clothing. 2. Importance: Discretionary income is significant because it is the money that can be used for luxuries, or investment opportunities. It directly influences the standard of living and the personal financial comfort of the individual. It is also a key indicator for economic health, consumer spending levels and predicting future spending trends. 3. Calculation: Discretionary income can be calculated by subtracting essential living expenses and taxes from gross income. These essential expenses include rent or mortgage, utilities, food, transportation, insurance, and health care. The rest, the discretionary income, can then be used for savings, entertainment, vacation, or any other non-essential purchases.

Importance

Discretionary income is important in the realms of business and finance because it represents the portion of a person’s income that is available for spending after essentials such as taxes and personal necessities like food, shelter, and clothing have been covered. This is the money consumers have left to spend on luxury items, entertainment, vacations, or it could be used for saving or investing. From the business perspective, understanding consumers’ discretionary income can help them strategize their marketing efforts, product pricing and target audience since it directly influences consumers’ buying power and spending habits. Moreover, on a larger scale, discretionary income is an economic indicator, helping governments to understand the financial health of their citizens, and formulating economic plans and policies.

Explanation

Discretionary income is a crucial element in personal finance management as it serves as a determinant of one’s financial health and spending behavior. Essentially, it stands for the portion of income left over after paying off all necessary obligations, including taxes and bills, and accounting for the basic living expenses such as food, housing, and healthcare. It’s a reflection of one’s financial security, stability, and capacity to maintain a certain lifestyle. It dictates the flexibility one has with their money, whether they can afford unnecessary expenditures, or have the opportunity to invest or save for future purposes. The use of discretionary income varies from person to person based on their goals, needs, or wants. Some individuals may choose to save or invest their discretionary income to build wealth, plan for their retirement, or handle potential financial emergencies. Others may use this income to elevate their lifestyle by spending on non-essentials like leisure activities, travel, or luxury goods. Businesses also pay attention to trends in discretionary income since they significantly influence consumer spending habits. Increases or decreases in discretionary income can serve as an economic indicator, providing insight into the overall health of the economy.

Examples

1. A software engineer living in San Francisco earns $120,000 annually. After taking out essentials expenditures like rent, taxes, utilities, groceries and transportation, which account for $80,000, he’s left with $40,000 as discretionary income. This could be used for non-essential purchases, such as buying gadgets, traveling or splurging on upscale restaurants. 2. A retired couple in Florida has an annual income of $60,000 from their savings and social security. After accounting for fixed expenses like home maintenance, utilities, health insurance and groceries, which total up to $48,000, they have $12,000 (or $1,000 per month) as discretionary income. They decide to spend it on golf club memberships, vacation trips and buying gifts for their grandchildren. 3. A school teacher in New York earns $70,000 a year. After accounting for necessities that cost $50,000 per year, she is left with $20,000 in discretionary income. She decides to use this discretionary income to pay for extra curriculum activities for her children, home improvements, and, occasionally, luxury items like designer clothes.

Frequently Asked Questions(FAQ)

What is ‘discretionary income’?

Discretionary income refers to the amount of income that an individual or household has left to spend or save after paying for necessities, such as taxes, utilities, food, and necessary living expenses.

How does discretionary income differ from disposable income?

While both terms refer to the amount of money one has left after paying taxes, there is a subtle difference. While disposable income includes money spent on necessities, discretionary income only considers the money left over after all necessary expenses have been paid.

How is discretionary income calculated?

Discretionary income is calculated by subtracting all taxes and living expenses, including rent or mortgage payments, utility bills, groceries, and essential items, from a person’s gross income.

Why is discretionary income important?

Discretionary income is crucial because it is the portion of your income that can be used to make investments, plan for retirement, save for emergencies, or spend on luxury items and leisure activities. A higher level of discretionary income indicates a higher quality of life.

What can affect my discretionary income?

Several factors can affect your discretionary income, including your gross income, the taxes you pay, the cost of living in your area, and your necessary living expenses.

How can I increase my discretionary income?

You can increase your discretionary income by boosting your earnings, reducing your taxes, or cutting back on living expenses. Budgeting effectively is also a helpful method to increase discretionary income.

Can discretionary income be negative?

Yes, if a person’s necessary living expenses exceed their income after taxes, then their discretionary income can be negative. This suggests that the individual is going into debt to cover their essential costs.

How does a change in my discretionary income affect my lifestyle?

A change in discretionary income can significantly affect your lifestyle. An increase can allow you to add luxuries or save for future financial goals. In contrast, a decrease might require budget cuts, such as less dining out or reduced spending on non-essentials.

Related Finance Terms

Disposable Income
Savings
Non-Discretionary Expenses
Consumer Spending
Personal Budget

Table of Contents