Disposable Income vs. Discretionary Income

During the winter, many young adults get jobs to help fund their holiday shopping. Getting a part-time job can be a great, not only for buying gifts, but also for experiencing what it is like to earn a living. One of the first things people learn from their first jobs is that not all of their hourly wages finds its way into their paychecks. Paychecks are reduced by taxes and other required expenses, which are deducted before you ever get your pay. What is left over is known as disposable income. This is money that you are free to spend as needed for bills, paying off debts, or buying gifts. Young workers must anticipate that their disposable income will be significantly less than what they earn.

Disposable income: Disposable income is equal to your earned salary (or gross pay) minus federal and state taxes, Social Security withholdings, and Medicare withholdings. To find out what percentage of your gross pay you will predictably keep each pay period, look at your first paycheck. It will list all the standard withholdings that will occur. Follow this formula: Divide the sum of all the withholdings by your gross pay. Multiply the result by 100, subtract that result from 100.

100 – [(withholdings ÷ gross pay) x 100]

This is the percentage of your salary that you will receive as disposable income. By calculating this figure ahead of time, you will know how much income to expect each month.

Discretionary income: Discretionary income is what is left over from your disposable income after all your bills are paid. Since most bills such as car insurance premiums or rent tend to cost the same amount each month, you can calculate your expected discretionary income so you know what to expect. To calculate discretionary income, subtract all your regular monthly bills and expenses from your monthly disposable income.

Discretionary income = disposable income – monthly expenses

You should base your shopping budget on your discretionary income, not your disposable income. This way you can be aware of exactly how much money you have free and avoid overspending.

READERS, what do you think?

Did you know about all the tax withholdings from your paycheck? What do you think they go to pay?