What Is Disposable Income?
Disposable income, also known as net pay, refers to the income that’s left for personal spending after direct taxes, such as federal and state income taxes, have been accounted for. It is a key concept in personal budgeting and economic policy.
How Is Disposable Income Calculated?
Disposable income is calculated by subtracting income and payroll taxes from gross pay; the remainder is disposable income.
Disposable Income Formula
Personal Income − Personal Income Taxes = Disposable Income
Disposable Income Example
Using the formula above, let’s say you earn $50,000 a year. In that bracket, about 20% of total income will go toward a combination of federal, state and local income taxes. According to this example, that means $10,000 is taken in income taxes. Subtracting $10,000 from $50,000 leaves you with $40,000 in disposable income.
That $40,000 is available to spend on housing, transportation, food, health care, and other necessities. Once all of those essential costs are covered, you’re left with your discretionary income.
Why Is Disposable Income Important?
Understanding and calculating disposable income is a key step in preparing a personal budget since it is the amount you actually have to make spending or saving decisions. Disposable income is also an important concept for those studying and planning government economic policies.
The Bureau of Economic Analysis (BEA) reports disposable income as one of three main measures of income. It’s also part of the government’s calculations of consumer spending and figures in the consumer price index. Disposable income is also used to help set Social Security benefits, as well as government transfers such as unemployment and disability.
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