When creating a budget and set financial goals for yourself, it is important that you know how much money you are working with. Spoiler: it’s not the number on your biweekly pay stub — it’s your disposable income.
Your disposable income is how much you can spend after Uncle Sam gets a pay cut. Let’s start with the basics.
What is Disposable Income?
Disposable income, also known as disposable personal income (DPI) is the amount of net income you have after you’ve paid local, state, and federal taxes. This number is also an important economic indicator used to measure the health of the economy. When consumers have more disposable income, it means they have more money to pour back into the economy.
As of 2021, the average American has $56,088 in disposable income per year, according to most recent data from the Fed.
“Disposable income is used to pay for living expenses and other expenses,” says Trevor Yochum, certified financial planner, CIMA®, managing partner and investment advisor at Incompass Financial Partners. essential needs of life.
Your disposable income will be different from everyone else’s and will likely change throughout your life as your financial circumstances change. Here’s a closer look at average disposable income per capita over the last century, or so.
How do you calculate your disposable income?
You can find out the disposable income you earn each month by calculating the difference between the income you earn and the taxes you pay. The taxes you owe will depend on your salary, your state, and your filing status. For tax year 2023, tax rates range from 10% to 37%.
Assuming you make $2,500 per month and your employer deducts $250 on each paycheck to pay taxes, your monthly disposable income would come to $2,000.
Note: If you are self-employed, you will not have an employer do the withholding tax enhancement for you. You’ll need to check the numbers yourself to make sure you have enough money to cover what you owe when tax season arrives.
What is disposable income used for?
First of all, your disposable income should not be confused with your discretionary income. It is the amount of money you have left after all your necessary expenses have been covered. You have the freedom to use these funds however you want. On the contrary, your disposable income should be used to cover living expenses and non-negotiable expenses.
“Disposable income is used for living expenses and other essential needs [such as your] mortgage or rent, transportation, health and food insurance. What is left after the essentials have been taken care of is discretionary income,” says Yochum. “Discretionary income that can be saved or used for entertainment [such as] travel, eat out, concert or sporting event. ”
To calculate discretionary income, you would take your disposable income and subtract all payments needed to cover your essential needs. Some budgeting strategies like Method 50/20/30 You can make this a little simpler by categorizing your spending into your needs (50%), wants (20%), savings and debt payments (30%). ).
“If someone has lost income, discretionary spending should be an area that individuals look at to determine what expenses can be eliminated from their budget,” Yochum says.
Carried away
Building a strong financial foundation for yourself starts with understanding the basics. By looking closely at how much income you are bringing in and how best to allocate those funds, you can ensure that you can weather any financial setbacks that come your way and achieve success. be all his main money goals.
