How Does Discretionary Income Work?

Proceed at your own discretion.

Just recently I went on a hike alongside a river with some beautiful views of waterfalls, cliffs, and nature.  At a certain point, there was a sign that stated the phrase from above: Proceed at your own discretion.

Now, I think a more simple term would have helped someone like me, but luckily there was additional signage that let me know to use extreme caution… and that since 2003 there had been X amount of drownings.   

Basically, if I wanted to go further on the hike it was up to me, it was my choice, but don’t do anything stupid.

But what does discretion have to do with money? Lots actually. Especially when you are discussing the subject of discretionary income.

What is Discretionary Income?

The definition of the term discretion literally means “Available for the use at the discretion (choice) of the user.”

In other words, discretionary income is the amount of money someone has to do whatever they want with after they pay their necessary bills (Fixed expenses).

Investopedia explains discretionary income best where the definition here:

Discretionary income is the amount of income that a household or individual has to invest, save or spend after taxes and necessities are paid.

Discretionary income is similar to disposable income because it's derived from it. However, there is one key difference between discretionary and disposable income.

Disposable income does not take necessities into account. Common necessities a household or individual may have are things like rent/housing, clothing, food, bill payments, goods, services, and other typical expenses.

So for example, back in 2012 before I met my wife, I made about $3,000 every month after taxes. After all my bills were paid, I had about $1,000 leftover to do whatever I wanted with… which typically meant “Spend it all on weekend nightlife.”

Basically, I had $1,000 worth of discretionary income per month. But why did knowing how much I had in discretionary income even matter?

Why knowing your discretionary income number is important.

There are numerous reasons as to why you should know what you discretionary income number is but the biggest reason to know is this:

Are you in the positive or negative each month? In other words are you red or green when the month ends?

A key money philosophy I heard one time was to always assess your personal finances as if they were a business. Basically, is your business profitable each month? Or is it bleeding money?

Secondly, having a grip on your spending and money habits typically boils down to knowing where your money goes. If you know your discretionary income is $1,000 each month, then you can set savings, retirement, and debt payoff goals based on that number.

With a recent study indicating that 8 in 10 live paycheck to paycheck, more people knowing how much discretionary income they have at their disposal each month couldn’t be a bad thing.

Lastly, knowing what your discretionary income is could determine how much you pay each month towards your student loans if you have them.

Discretionary Income & Student Loans

discretionary income student loans

Typically if you have heard the term discretionary income, it has something to do with student loans.

If someone is on income based repayment (IBR) then discretionary income is used to see how much that person would pay toward their student loans each month. Student loan repayment plans that use a percentage of discretionary income include:

  • Income Based Repayment (IBR) – 10% or 15%
  • Pay as You Earn (PAYE) – 10%
  • Revised Pay as You Earn (RePaye) – 10%
  • Income Contingent Repayment – 20%

*Percentages not always exact

Personal Note: Lauren used the IBR plan for her student loans from March 2015 to March 2019 because what she earned wasn’t enough to live off of and pay the full amount toward her student loans.

So each month we were responsible for paying 10% of her discretionary income. Then each March, she would submit the required paperwork for income based repayments, which included her salary. The percentage she paid back increased because her salary increased each year.

March 2019 marked the first year we did not use the IBR plan because we are ahead of her (our) student loans so much!

See also, How Student Loan Interest Works

How do you calculate your discretionary income?

There are really two ways to calculate your discretionary income:

  1. For your general knowledge so you can implement a pay yourself first strategy
  2. So you know about how much to pay back in student loans based off your discretionary income.

For starters, to see how much discretionary income you have each month – or “Leftover” money used a fixed expense and variable expense budget sheet.

Simply take your net monthly income and subtract your fixed expenses. The result is your discretionary income (In the example earlier my discretionary income was $1,000 per month)

If you have student loans and you want to know what your repayment might be like, the best way to figure that out is to use a discretionary income calculator, or just the simple formula below:

Household Income (AGI) – 150% Of Federal Poverty Guideline = Discretionary Income

150% Poverty Line Based on Household Size 2017:

  • 1 = $18,000
  • 2 = $24,360
  • 3 = $30,360
  • 4 = $36,900

Ways to increase your discretionary income

The quickest way to increase the amount of money you can use however you want, is to actually do the opposite.

Stop doing whatever you want with your money.

In other words, cut back on spending and live below your means to increase your discretionary income. While this will not impact your student loan repayments, (Only more income will do that) cutting back and living stingy is a great financial habit.

Consider doing the following to increase the amount of discretionary income:

  1. Assess needs vs wants
  2. Never buy anything over $100 without giving yourself a 48 hour grace period
  3. Checkout of online shopping carts 1x per month
  4. Identify reasons to delay gratification
  5. Cancel all your email subscriptions
  6. Throw away coupons
  7. Set a darn budget for yourself!

At a certain point, cutting back spending will only increase your discretionary income so much. For example, if someone has $500 in discretionary income and they cut back their variable expenditures as much as possible and it only generates another $200 – well they’re pretty much stuck at $700.

For scenarios like this, the best way to increase your discretionary income is to increase your income! Ideas to make more money include:

  1. Walk dogs
  2. Make stuff and sell it online
  3. Have a yard sale
  4. Start a small business on the side
  5. Complete paid surveys (<—– pretty boring, won’t lie)
  6. Serve beer at festivals and parades (For a vendor legally)
  7. Cut grass
  8. Get creative

See also, 21 Ways to Make $500 Fast.

Lastly, another way to increase your discretionary income exponentially is to pay off debt that quickly increases your cash flow.

For example, if you pay off a credit card that has a minimum of $25 you won’t get much back in return as far as cash flow goes. However, the $350 car payment could increase your discretionary income quickly

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My Take: Why should you focus on increasing discretionary income?

I guess at the end of the day, it doesn’t really matter whether you call is discretionary income, surplus money or just money, having a positive cash flow is essential.

The term positive cash flow is commonly used with business because without capital, most businesses struggle. But why don’t more individuals take their income and treat it the same way?


In 2014 when I traded in my paid off car for a brand new truck I had no clue I was royally jacking up my discretionary income number. For one I had not clue how much I really brought home or how much I spent, so when I injected a $350 payment because the car dealer said I could afford it I thought nothing of it.

Then in 2015 I bought some real estate and I very quickly was tapped. My discretionary income was somewhere in the neighborhood of $350 when I factored in all my other spending habits.

I share these personal anecdotes because had I known about my discretionary income number, or how much I had leftover each month, I think I would have thought differently about a few things.  

Not that we can go back in time, but I really wish I would have known this right after college. I could have placed a bigger emphasis on saving for the future instead of just saving for Friday night.

So my suggestion for you is to go figure out how much you have leftover each month and proceed at your own discretion…. Just make sure you watch your (Financial) step!

Question: What is your discretionary income number?

how does discretionary income work?

Josh writes about ways to make money, pay off debt, and improve yourself. After paying off $200,000 in student loans with his wife in less than four years, Josh started Money Life Wax and has been featured on Forbes, Business Insider, Huffington Post and more! In addition to being a life-long entrepreneur, Josh and his wife enjoy spending time with their chocolate lab named Morgan, working out, helping others with their debt and recommend using Personal Capital to track your finances.