Disposable Income

The money that remains of an individual’s salary after paying all local, state, and federal taxes

What is Disposable Income?

Disposable Income is the money that remains of an individual’s salary after he/she pays local, state, and federal taxes. It is also known as disposable personal income or net pay. The disposable income of a household comprises earnings plus unemployment benefits and capital income.

 

Disposable Income

 

Disposable income is one of the main parameters to determine consumer spending. It is also one of the important factors for determining demand. Disposable income shows the amount of goods and services purchased at different prices over a particular period. It implies that the amount of disposable income available to someone can help determine the amount of money expensed on goods and services.

 

Summary

  • Disposable income is the portion of income available to an income earner after all income taxes are deducted.
  • It is used by analysts to measure consumer spending, payment ability, probable future savings, and the overall health of a nation’s economy.
  • Disposable income can be used to determine the financial reserves of households and the money available to be spent on goods and services.

 

Formula for Disposable Income

 

Disposable Income = Personal Income – Personal Income Taxes

 

Suppose a family’s aggregate income is $150,000, along with an effective tax rate of 27%. The disposable income for the family will be $109,500 [$150,000 – (27% x $150,000)].

 

Significance of Disposable Income

Disposable income is used by analysts to measure the state of an economy. It can also be used to measure the households’ financial reserves. It helps economists to measure the savings and spending rates of the households. Disposable income is used to derive several economic indicators and measures such as discretionary income and personal saving rate.

When the disposable income has accounted for payments of all necessities – such as food, health insurance, and mortgage – the result is the discretionary income. The discretionary income is a part of disposable income after payments of necessities have been made. Income earners can save or spend the discretionary income as he/she wishes.

In the event of financial pressure, such as economic downturn and job loss, discretionary income will drastically reduce. A percentage of disposable income – the personal savings rate – goes into savings for later use or retirement.

The federal government uses the disposable income to determine the amount of money to be withheld from the wages of an individual for payments to third parties or back tax payments. The disposable income is used to determine the amount of money to be withheld from the paychecks of income earners.

The portion of disposable income that could be withheld can be a maximum of 25% of an individual’s disposable income or the amount that results in an individual’s weekly income to be greater than 30 times the minimum federal income, whichever is low. While calculating the disposable income, the federal government also deducts the premiums of health insurance and contributions from involuntary retirement plans from the gross income.

In the above example, assume the family needs to pay a yearly premium of $15,000 for health insurance and $7,500 in retirement contributions. The disposable income for purposes of withholding income will reduce from $109,500 to $87,000 ($109,500 – $15,000 – $7,500 = $87,000).

 

Per Capita Disposable Income

Disposable income is a useful measure of the health of an economy. Hence, it is one of the important metrics examined by government officials and analysts. The disposable income data helps to analyze the consumer’s ability to make purchases, make payments, and accumulate savings for the future. The Organization for Economic Cooperation and Development (OECD) collates the financial data of various countries, tracks, and reports the per capita disposable income for households.

The aggregate personal income for the United States was about $15 trillion in 2019. The United States reported the highest per capita disposable income, with each American generating $45,579 of disposable income. Furthermore, Luxembourg, Australia, Germany, and Switzerland were among the countries with the ten-largest per capita disposable incomes.

 

Additional Resources

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • Discretionary Income
  • Unemployment
  • Savings Account
  • Gross Income

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