Disposable income, also known as disposable personal income (DPI), is the net amount of money you have after you’ve paid your taxes. Once Uncle Sam has taken his cut, disposable income is the money you have left to spend, save, or invest.
Sometimes the term disposable income is used interchangeably with discretionary income - but they are different. Discretionary income is any leftover money after all other financial obligations have been met, including taxes, rent or mortgage payments, bills, food, and other necessary expenses. It’s the net amount you can then spend at your discretion.
Why managing discretionary and disposable income matters
The money remaining after paying taxes and other mandatory expenses is a key player in your financial journey. It's the amount you can either save or spend on non-essential items or experiences. Figuring out how best to handle your disposable income can drastically shape your future financial health.
How to calculate your disposable income, step by step
Determine your total income: Add up all sources of liquid income including salary, bonuses, tips, and rental income.
Subtract taxes and deductions: Next, subtract the amount of taxes you pay from your total income. This includes federal and state income tax, as well as any other taxes like Medicare or Social Security. Don’t forget deductions! Subtract the amount you pay on deductions like health insurance costs and 401(k) retirement contributions.
The amount left after taxes and deductions is your net disposable income - the total amount of liquid money you have to cover your essential living expenses, such as rent or mortgage, insurance, food, utility bills, clothing, savings, and retirement investments.
Got any left over after all that? If so, that’s your discretionary fund - whatever’s left over for things like vacations or gifts after you’ve covered your essentials and other responsibilities. You get to decide whether to spend, save, or invest it.
How to make the most of your disposable income
Now that you know what disposable income is and why it's important, let's dive into how you can make the most of it. Here are a few tips:
Craft a budget
A budget provides a clear snapshot of where your money goes each month. It's a tool that helps you allocate funds effectively and pinpoint areas for potential savings.
Make saving a priority
Cultivate the habit of saving. Even putting aside a small amount regularly can snowball into a substantial sum over time, especially if you invest it wisely.
Spend wisely
Just because you have disposable income doesn't mean you should splurge mindlessly. Being intentional about your purchases can help keep focus on bringing value to your life (quality over quantity, for example). As they say, a penny saved is a penny earned.
Invest in yourself
Consider using some of your disposable income on self care, personal and professional growth, and experiences that bring you joy. This could mean taking up a new hobby, attending workshops or classes, earning a certification or degree, or investing in your physical and mental well-being.
FAQs
Q: What is disposable income?
A: Disposable income is the net money that remains after paying all the taxes and essential living expenses from your total gross income.
Q: Why is disposable income important?
A: Disposable income is vital as it's the money you can use for savings, investments, or spending on non-essential items. Proper management of disposable income can improve your financial health.
Q: How can I increase my disposable income?
A: You can increase your disposable income by increasing your income sources, reducing taxes, cutting down on unnecessary expenses or discretionary spending, or a combination of these strategies.
Q: How does budgeting impact disposable income?
A: Budgeting can help you to allocate and track your disposable income effectively, helping you to control your expenditures and hopefully increase savings.
Q: How much of my disposable income should I save?
A: There is no one-size-fits-all formula. The amount of disposable income you should save depends on your unique goals and responsibilities. One common approach is the 50/15/5 rule: Allocate 50% of your income to needs, save 15% of pretax income toward retirement, and set 5% aside for short-term liquid savings and unexpected expenses.
There are many other common approaches with similar guidelines, such as the 50-30-20 rule. And your percentages will likely change with your life! But whichever formula you use, the overall goal is to earmark strategic percentages of your income for essentials, discretionary, and disposable income.
Q: Can disposable income be negative?
A: Disposable income can be negative if your expenses, including taxes and mandatory charges, exceed your total income.
Q: Does disposable income include savings?
A: Yes, disposable income includes the money you choose to save after paying for taxes and necessary expenditures.
Q: How often should I review my disposable income?
A: Review your disposable income plan regularly! At minimum, review it annually as part of a regular financial check-up.This helps ensure you’re following it consistently. But also review your disposable income whenever there's a significant change in your income or expenses.
Q: How does disposable income affect the economy?
A: Disposable income and discretionary income can both impact the economy. When people have more disposable income, they tend to spend more, stimulating economic growth. Conversely, less disposable income can slow down economic growth.
Q: Can disposable income help in achieving financial goals?
A: Managing your disposable income strategically and wisely can help you achieve financial goals such as creating an emergency fund, owning a home, and preparing for retirement.
Want more tips for living your best life? Visit the Greenlight Learning Center for helpful resources on all things family, finance, and fun.
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