Discretionary income is a crucial metric to measure economic health.
Split the amount of money after filing taxes into household disposable income and discretionary income. The measures impact individuals, households, businesses and indicate general economic health.
Individuals can spend discretionary income on non-essential items, such as goods, services, vacations, or luxury products. Understanding your discretionary income is key to budgeting — whether you want to pay off debts, spend, or save.
Let's get to the following commonly asked questions:
Let's start with a discretionary income definition. Essentially, it's the money left after paying all necessary expenses. These include income tax, rent, mortgage rates, transport, food, utilities, and insurance.
Because individuals spend this after-tax income on non-essential goods, it's the first to shrink in crises or economic downturns. Discretionary income indicates economic health: the more discretionary income, the more financial independence.
Many credit products, such as debt consolidation loans or current student loans, offer repayment plans based on your discretionary income. However, it is not the same as disposable income. Read on to find out about disposable income vs. discretionary income.
Important: Some people apply for a credit card to increase their discretionary income. However, increasing credit products or taking out a personal loan is not the same as increasing discretionary gross income.
Disposable and discretionary income are terms used in place of each other. However, the meanings of disposable income and discretionary are different.
The differences between disposable income and discretionary income are in the non-essential expenses. Disposable incomes are the capital gains used to meet essential and non-essential living expenses after taxes.
On the other hand, discretionary income is the amount of money left after essential expenses. Disposable income per capita is calculated and monitored by financial analysts. Types of income include wages, pensions or social security.
The Organisation for Economic Cooperation and Development (OECD) keeps an eye on how much households spend and save. Monitoring disposable income and discretionary income can help predict the propensity to consume.
Economists and government officials use discretionary income as a marker of economic health and consumer spending. They can calculate other economic indicators with discretionary income, such as the marginal propensity to consume.
Discretionary income levels typically fluctuate in line with current prices and current taxes. When the economic output is high, so are discretionary income levels. Accordingly, when inflation occurs, discretionary income falls.
It goes without saying when times are tight financially, households and businesses spend less on non-essentials. It's a sign of the economy falling when consumers start dipping into their savings.
Discretionary income is one of the primary drivers of the economy. Higher levels of discretionary income result in increased spending and production. Each is a vital indicator of a flourishing economy.
There are three ways to use discretionary income. These include spending, investing and saving.
Discretionary spending is cyclical. When discretionary income increases, consumption expenditure boosts. For example, a discretionary expense might include luxury food, clothing, vacations, or a loan payment.
As the consumer spends more on goods and services, businesses thrive. They might reinvest this corporate finance to grow their operation in the business environment. Thus, leading to increased jobs and furthers net discretionary income.
Moreover, businesses might use the discretionary income to pay for employees' health insurance or life insurance. Or instead, they might release it back to the shareholders, enhancing their discretionary income.
Similarly, when individuals and households invest in companies, it provides additional capital for businesses. This capital can improve business growth rates, additionally increasing job prospects.
Plus, investing strategies are supposed to result in returns for the investor. Consider investing the money you have left after necessities in mutual funds or the stock market.
Note: Investment properties work differently. Typically, you'll need to apply for home loans. Therefore, the discretionary income after real estate financing might be more marginal in the short term.
When individuals make significant household savings, it's a sign of substantial disposable income. Unlike the cash in checking accounts, saving accounts have better fixed-term or CD rates. They typically save money with commercial banking in a savings account.
Banks keep the individual's income and savings safe, lending out some of it to other individuals who need the funds imminently. For example, student loans or additional credit.
Another form of saving is through retirement planning. Australians invest their discretionary household income into retirement accounts, known as superannuation funds.
However, by investing a portion of your discretionary net income into savings accounts early, you won't need to wait until the end of your life to retire. Check savings rates to find the best place for your money.
For example, an individual earns $50,000 a year. With local taxes at 32.5%, their household net income minus tax is $33,750.
Monthly expenses equal $2,000.
Therefore, their yearly disposable income is the money left over: $9,750.
Note: Understanding how to calculate discretionary income for student loan payments. Many loans use it for income-based repayment plans.
As with the example above, it's straightforward to calculate discretionary income available. Take your personal income after tax rates. Minus all necessary expenses (e.g. rent, mortgage repayments, essential food items, etc.).
The results can be a measure of the health of your personal finances. If you have a significant amount of disposable income and discretionary income, you can invest, save, spend, or have fun.
On the other hand, if you have marginal discretionary income, you may need to reassess your finances. Remember that discretionary income-driven repayment plans are popular with certain credit products, and this is especially true of income for student loans.
Discretionary income is a crucial metric to assess economic health and a person's income and budget. Financial analysts can predict consumer spending and economic turns on a broader scale. In economic falls, individuals have less to spend on non-essential goods.
In turn, this feeds back into employees and jobs. Comparatively, individuals can use their discretionary income to measure their financial wellbeing.
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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs, or financial situation.