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How Discretionary Income Works

        Money | Taxes

Calculating and Using Discretionary Income

In the United States, personal income data is collected by the U.S. Census Bureau and tracked by the Bureau of Labor Statistics. That includes money earned from wages, salaries and self-employment, as well as pension and other retirement income, unemployment benefits, Social Security payments and other government assistance. It also covers income earned on property from rents, interest and dividends [sources: Bureau of Labor Statistics, Inc.].

The Census Bureau first deducts taxes owed from personal income to determine disposable income. To get to discretionary income, economists then deduct the so-called necessities: mortgage and rent payments, transportation, food, insurance and pension payments, clothing, and healthcare. They don't include non-essentials, like entertainment, alcohol and — yes — education. The amount that remains is the person or family's discretionary income [source: Inc.].

Generally, a person or household has two choices about what to do with discretionary income: save it or spend it. By calculating your own discretionary income, you can create a budget, pay down debt and put some of that sweet cash away for a rainy day, an unexpected emergency, a trip to the Bahamas or maybe your kids' college tuition.

Squirreling that extra dough is probably a sound financial strategy. It's also not very much fun. Perhaps that's why many folks choose to spend so much of their discretionary income. The average American household spends 28 percent of its income – or more than $12,000 per year – on discretionary things like entertainment and dining out [source: Experian].