Despite its name, disposable income isn't money you throw in the trash. It describes your earnings after taxes and other necessary deductions. For most people, disposable income is the money used to pay everyday living costs, so it's important to understand how to calculate it—and what it means for your budgeting and spending, as well as the overall economy.
What is disposable income?
Disposable income is the money you have control over, aka the income you have at your disposal. It becomes the basis for your budget—the total amount you can save or spend. On a broader scale, disposable income trends could help economists better understand how the larger economy might fare.
More technically, disposable income—sometimes called disposable personal income (DPI)—is how much money is left after mandatory deductions. These tend to be taxes, including income tax, Social Security (which might be labeled as OASDI on your paycheck) and Medicare contributions, and state unemployment insurance tax. It isn't necessarily the net pay dollar amount you get to keep from each paycheck. That's because elective deductions, such as retirement account contributions and health insurance premiums, are considered part of your disposable income.
How do you calculate disposable income?
Disposable income = personal income - mandatory deductions
The amount of taxes that gets deducted from your pay depends on a few things: how much you earn, where you live (because some states don't charge income tax, some do, and some cities do too), and how you fill out paperwork when you start a job, such as tax withholdings on Form W-4.
Here are 2 more detailed steps to calculating your disposable income, which you could then use to create a budget.
- Determine your gross income. Gross income is your total earnings before any deductions, whether elective (like retirement contributions) or mandatory (like taxes). If your gross income varies month to month, you might need to estimate. Assume a little less than what might actually come in to avoid not being able to cover your planned expenses. It's easier to budget for less income and then allocate extra dollars if you have them.
- Subtract mandatory deductions. Next, figure out which mandatory deductions to subtract by checking your paystub to see what else gets taken out of your paycheck. Remember to subtract only the deductions required by law, such as federal, state, and local taxes, Social Security contributions, Medicare taxes, state unemployment insurance contributions, and any other mandatory deductions (such as contributions to state family leave plans). Don't include deductions you'd legally be allowed to alter, such as premiums for life, medical, or dental insurance.
What to do with disposable income
You'll probably use a good chunk of your disposable income to cover your regular living expenses and making minimum payments on any debt you owe, including credit cards, auto loans, and student loans.
With any money left over, consider building an emergency fund, making pre-tax contributions to retirement and spending accounts, which could save you money in the long run by reducing your taxable income, as well as giving your funds a chance to potentially grow over time, and paying more than the minimums on high-interest debt. You could also think about setting aside cash for specific long-term goals in interest-earning accounts or investing through a brokerage account. It's important to enjoy yourself in the short term too, so if you can swing it, budget for those nice-to-haves that make you happy now.
Disposable income vs. discretionary income
It's common to confuse disposable income and discretionary income, but there's a key difference. For one, disposable income—reminder, your earnings minus mandatory deductions—is used to calculate what portion of your wages might be garnished for payments you owe, such as child support or to creditors.
Discretionary income, on the other hand, is the money remaining after taxes and essential cost-of-living expenses, such as food and housing. In other words, your discretionary income is what's left to invest or spend on nonessential items. Wage garnishment formulas don't take your discretionary income into account.
Understanding both your disposable and discretionary income could help you budget more effectively. For instance, if your essentials cost so much that there's no budget left to spend on fun stuff, like a vacation, you might look for ways to reevaluate what is essential and see if there's anything that can be cut.
Why do economists track disposable income?
Disposable income numbers give clues about households' economic health. Economists closely monitor disposable income trends to track the following:
Consumer spending and economic growth
Economists are interested in disposable income because it's the primary driver of consumer spending and saving. When disposable income rises, people generally have more money to spend. If they spend more, that tends to lead to economic growth.
If instead people have less disposable income, then they might cut back on spending. In turn, economic growth could slow. Economists can use disposable income data to gauge the potential impact of consumer behavior and help inform decisions about how the government manages debt and where it allocates money to try to grow the economy.
Income inequality and poverty analysis
Disposable income data is also helpful for assessing income disparities and poverty levels. By comparing disposable income levels across different demographics and in different areas, policymakers can identify where inequality or poverty needs to be addressed.
Curious about Americans' disposable income? The Federal Reserve Economic Data Disposable Personal Income report shows how this has changed over time and where it stands lately in the US.