What is Discretionary Income? Here’s How to Calculate It

If you’re like most people, bills and other necessities eat up the majority of your paycheck, meaning your money is practically spent before you even get it. You may have some extra cash left over, but if you’re smart with your finances, you know that doesn’t mean you should spend it all if you can help it.

The money you have left after paying for the essentials is what’s known as discretionary income. Understanding this portion of your income is important, as it’s often the most crucial part for your budgeting and calculating payment rates for debts like student loans.

What is discretionary income?

In the simplest terms, discretionary income is any money you have left after paying for necessities, like taxes, fees, bills, and everyday expenses (e.g. groceries). It's money you can use to pay for activities (aka “fun stuff”) and other nonessentials.

Any time you spend money on things that are nice to have but you don’t necessarily need, you’re spending discretionary income. Examples include nonessential goods and services, luxury items, entertainment, vacations, and beyond. (Although it’s wise to put most of it into your savings.)

Understanding discretionary income is crucial whether you’re the federal government calculating income-driven repayment (IDR) plans or student loan fees — which make about 10–15% of your total discretionary income — or if you’re an individual simply looking to track your income and budget smarter.

Disposable vs. discretionary income: What’s the difference?

Disposable income and discretionary income are often mixed up due to their similarity. They both include non-allocated funds, or funds leftover after you pay for mandatory expenses like rent, utilities, etc.

The difference? Disposable income comprises all the money you earn after paying your taxes but before you pay any bills or essential expenses. If you spend this money carelessly, you may be unable to cover even your essential bills or necessary purchases.

Discretionary income on the other hand is the money you have to spend on nonessential and luxury items or services. You will still have the funds to pay your bills on time if you blow through all your discretionary income (but again, that doesn’t mean you should).

Tracking your discretionary income helps you manage your cash flow and stick to a budget. It’s a big part of handling your finances more wisely.

Discretionary income considerations for student loans

When you apply for loans — including student loans — you have a few repayment plan options to consider. Many are IDR plans, which are tied to your income.

Your loan payments are directly adjusted to match your discretionary income, which means they may increase or decrease as your income changes. The federal poverty level, your mortgage, and even your tax return can influence your payments.

Income-driven student loan repayment plans include:

1. Pay As You Earn (PAYE) plans. These repayment plans often cap your monthly payments at 10% of your available discretionary income. After 20 years of on-time payments, the Department of Education will forgive the remaining loan balance.

2. Revised Pay As You Earn (REPAYE) plans. Monthly payments are capped at 10% of your discretionary income, and the remaining balance is forgiven after 20 years if it was used for undergraduate studies. Loans for graduate or professional schools require up to 25 years of good-faith payments before they’re forgiven.

3. Income-Based Repayment (IBR) plans. If you’re a new borrower who took out a loan on or after July 1, 2014, the monthly payments are capped at 10% of your discretionary income. The cap is 15% for borrowers who took out loans before that date.

4. Income-Contingent Repayment (ICR) plans. Discretionary income is calculated differently for these plans. First, 100% of the poverty guideline is subtracted from your annual income. This guideline varies depending on your family size and the state you live in. Monthly payments are then set at 20% of that amount or at a fixed amount for a 12-year loan term — whichever rate is lower. To have the balance forgiven, you have to make good-faith payments for 25 years.

To sum it up, discretionary income is vital when calculating federal student loan repayments, so it’s key to understand what it is and how it works.

So, how is discretionary income calculated?

How to calculate your discretionary income for IDR plans

Here’s how to calculate your discretionary income like the Department of Education does for debt repayment plans. Note that this might not look the same as what you consider your actual discretionary income to be.

1. Calculate your adjusted gross income (AGI). This is your total income from all sources before taxes but after adjustments (e.g. educator expenses, student loan interest, alimony payments, and contributions to a retirement account).

2. Review the federal poverty guidelines for your state and family size.

3. Multiply the poverty guideline amount by 1.5 (skip this step if you’re looking at an ICR plan).

4. Subtract that amount (3) from your AGI (1).

If you need clarification on which plans you qualify for or what they mean, you can always reference the U.S. Department of Education's loan simulator tool and student loan calculator. It will help you understand what you qualify for, calculate your monthly payments under each plan, and allow you to compare them to any current goals you have.

Remember, there may be a big difference between your disposable and discretionary income since the latter includes the total after all your expenses and necessities are factored in.

Can discretionary income change?

Oh yes, your discretionary income can change. In fact, your discretionary income will likely vary every month or year at least a bit.

The following factors can affect your discretionary income:

- Changes in your salary or income. Your income may change if you were promoted, given a raise, found a new job, or lost your job.

- An updated marital status. After getting married, your household income includes that of your spouse. There are also new poverty guidelines, which are higher for a joint household.

- A growing family. New family members change your essential taxes, fees, and expenses.

- Moving to a new state. Each state has distinct poverty guidelines, so relocating could increase or decrease your discretionary income — and any payments tied to it.

- Adjustments to federal poverty guidelines. The federal poverty guidelines are updated annually, meaning your discretionary income may change based on those.

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Discretionary income is one of many ways to view your finances. But sometimes your expenses and bills can outpace your paycheck, leaving your discretionary income out of reach and possibly creating further debt.

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Disclaimer: Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.