Individuals and businesses earn income—money for providing goods or services or by investing capital in assets like individual retirement accounts (IRAs). Other sources of income include pensions or Social Security. This income may be used to fund day-to-day expenditures and necessities or to spend on things people want rather than need.
Income can be divided into two different categories: disposable and discretionary income.
Disposable income is the money you have left from your income after you pay taxes. It’s calculated using the following simple formula: disposable income = personal income – personal current taxes. For most people who receive a paycheck, disposable income is the net amount they receive in their check.
Learn more about disposable income, its importance as an economic indicator, and how it differs from discretionary income.
Significance of Disposable Income
Disposable income is used by analysts to measure the state of an economy. It can also be used to measure the households’ financial reserves. It helps economists to measure the savings and spending rates of the households. Disposable income is used to derive several economic indicators and measures such as discretionary income and personal saving rate.
When the disposable income has accounted for payments of all necessities – such as food, health insurance, and mortgage – the result is the discretionary income. The discretionary income is a part of disposable income after payments of necessities have been made. Income earners can save or spend the discretionary income as he/she wishes.
How does knowing what disposable income is help with budgeting?
Thinking of your discretionary income as your disposable income can actually be preventing you from budgeting successfully. When you start to consider the money you spend on your ‘essentials’ as disposable, as you should, you begin to realise that the cost of these items might actually be more flexible than you thought. Or even that your essentials might not be that essential after all.
Rethinking your views on disposable income can help you to make savings more effectively. The government considers all your income, aside from that owed in taxes, as disposable. This suggests that there is perhaps more choice involved in your ‘essential’ expenditure than you might realise. Consider your food shopping, for example. With a little more planning and a bit more time and effort, most of us would be able to cut down on our food shopping bill, thus increasing our discretionary income. This can mean more scope for saving, or simply more cash for the fun stuff.
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