What is discretionary income & how does it work?

Some of the salary you earn each month probably goes toward unavoidable expenses—like taxes and the costs of living.

Discretionary income is any money you have left over after paying for those things. And if you have federal student loans, your payments could be based on a percentage of your discretionary income. So it’s important to know how to calculate this number and how it could impact your student loan payments.

Key takeaways

• Discretionary income is the money you have left over after paying taxes and necessary cost-of-living expenses.
• Discretionary income and disposable income aren’t the same thing. Disposable income is simply the amount of money you have left after paying taxes.
• Understanding discretionary income is especially important when it comes to repaying federal student loans. That’s because many repayment plans are income-driven and have payments that are based on your discretionary income.

Discretionary income is the money you have left over after paying taxes and necessary cost-of-living expenses—like your rent or mortgage, utilities and groceries.

It’s called “discretionary income” because it can be used for discretionary expenses—nice-to-haves but not necessities. Discretionary expenses include things like dining out, streaming services, and tickets to movies, concerts and sporting events.

You’ve probably heard the term “disposable income” before. And if so, you might be wondering what the difference is between discretionary income and disposable income.

As the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) puts it, disposable income is simply “after-tax income”—it’s the amount of money you have left after paying taxes. “The formula is simple: personal income minus personal current taxes,” the BEA explains.

That means that your disposable income will always be higher than your discretionary income.

You can calculate your discretionary income by subtracting your cost-of-living expenses from your after-tax income.

For instance, let’s say you earn $48,000 a year and pay $10,000 toward taxes and $20,000 toward your cost-of-living expenses. What’s left over—$18,000 a year or $1,500 a month—is your discretionary income.

But keep in mind that when it comes to discretionary income for student loan borrowers, the Department of Education (DOE) doesn’t take individual expenses into account. Instead, the agency calculates a standardized discretionary income based on the borrower’s income and poverty guideline for their family size and state of residence.

Here’s how you would calculate discretionary income for federal student loans: 

• Find your adjusted gross income (AGI). 
• Check the current federal poverty guideline for your household size and state of residence. 
• Multiply that federal poverty guideline number by 1.5.
• Subtract what you get from your AGI.

So, the formula looks like this: salary – (your federal poverty guideline x 1.5) = your discretionary income.

Remember: Understanding discretionary income—and how the DOE calculates it—is especially important when it comes to repaying federal student loans.

That’s because borrowers have a variety of options when it comes time to enroll in a repayment plan. And many of those plans are income-driven and have payments that are based on your discretionary income.

Read on to learn more about income-driven repayment (IDR) plans. And keep in mind that for all IDR plans, the monthly payment will never exceed the amount you would pay on a 10-year Standard Repayment Plan. It’s also worth noting that any changes in your income, family size or state of residence could change your payment amount.

Pay As You Earn (PAYE) Repayment Plan

The Pay As You Earn Repayment (PAYE) Plan generally caps monthly payments at 10% of your discretionary income. After making payments for 20 years, the DOE forgives any remaining loan balance.

Revised Pay As You Earn (REPAYE) Repayment Plan

The Revised Pay As You Earn Repayment (REPAYE) Plan caps monthly payments at 10% of your discretionary income.

After making payments for 20 years, any remaining balance is forgiven if you used the loans for undergraduate study. But if you used any of the loans for graduate or professional school, you’ll need to make payments for 25 years before the loan balance is forgiven.

Income-Based Repayment (IBR) Plan

The Income-Based Repayment (IBR) Plan caps monthly payments at 10% of discretionary income for “new” borrowers—those who took out federal student loans on or after July 1, 2014. The cap rises to 15% for borrowers who took out loans before that date.

The DOE forgives any remaining loan balance after new borrowers make payments for 20 years and other borrowers make payments for 25 years.

Income-Contingent Repayment (ICR) Plan

With the Income-Contingent Repayment (ICR) Plan, discretionary income is calculated a little differently than it is for PAYE, REPAYE and IBR plans.

Your discretionary income is calculated as the difference between your annual income and 100% of the poverty guideline for your family size and state. Monthly payments are set as either 20% of your discretionary income or as fixed payments based on a 12-year loan term, whichever is lower.

You’ll need to make payments for 25 years before having the loan balance forgiven.

Because discretionary income plays into federal student loan repayments, it’s good to know how the DOE calculates this number.

That’s because federal student loan borrowers have the option to enroll in a variety of IDR plans that have payments based on their discretionary income.