What is a disposable income?

Disposable income is the portion of an individual’s income over which the recipient has complete discretion. It is that money which is available to invest, save, or spend as seemed fit for him, after deducting income taxes.

It is usually defined as the money left over after you've paid income tax. For example, if you earn a salary of Rs. 30,000 per month and pay Rs. 1,500 as tax, then your disposable income is Rs. 28,500 per month.

In other words, disposable income = Personal Income – Personal Income Taxes

The concept of disposable income is of economic and fiscal significance. It is one of the five major determinants of demand. Disposable income is also a vital determinant of consumer spending. It helps us to understand how much a household is left with for making spendings and savings, after accounting for taxes. When disposable income increases, a household’s purchasing power rises and vice versa.

People get confused between disposable income and discretionary income. Discretionary income is the disposable income minus all expenses made to meet basic human needs in order to survive and maintain a basic standard of living. 

A person may have lot of commitments to clear when he get his salary or some money from other sources. These include home loan EMIs, personal loans, credit card bills, etc. The balance money in his hand, after keeping aside for all these commitments is his discretionary income.

Discretionary Income = Disposable Income - Minimum Necessary Expenses

The traditional list of basic human needs includes food, clothing and shelter. As times evolved, necessities such as education, sanitation and healthcare also got added to this list. However, this list is not set in stone and can differ from person to person and on a macroscopic level, from country to country.

Understanding disposable income is vital to the essential task of financial planning. Knowing about disposable income helps us create realistic budgets and make wise investment decisions.

Disposable income is important because it allows you to make purchases that improve your quality of life. For example, you can use disposable income to meet regular expenses.