What is Discretionary Income?

Discretionary income is the income that remains after subtracting allowances for essential expenses, such as taxes and basic living expenses. The term discretionary income is used in connection with financial aid need analysis and income-driven repayment plans for a student loan.

Discretionary income and disposable income are related but different concepts. Disposable income is the net income after subtracting just income taxes and other amounts required by law to be withheld. Disposable income is greater than discretionary income.

Standardized Definition of Discretionary Income

The distinction between needs and wants is often subjective. Many people feel that a smartphone and cable TV are necessities, even though they really are luxuries.

A strict definition of necessary expenses includes only expenses where you would die or go to jail if you didn’t pay the expenses. Necessary expenses include food, housing, utilities and medical care.

To avoid subjectivity, definitions of discretionary income have been standardized as the difference between income and necessary expenses.

Definitions for Financial Aid Formulas

College financial aid formulas assess a portion of discretionary income as money available to pay for college costs. This becomes part of the Expected Family Contribution (EFC).

Financial aid formulas start with total income, which is the sum of adjusted gross income (AGI) and untaxed income and benefits.

Certain amounts are excluded from total income.

• Child support paid
• Taxable income associated with financial aid, such as the taxable portion of scholarships and grants and taxable earnings from Federal Work-Study and other need-based employment programs
• Taxable combat pay is also excluded

Next, certain allowances are subtracted from total income.

• Allowances for income taxes, such as federal income tax, state and other tax allowance, and Social Security tax allowance
• The income protection allowance is an allowance for basic living expenses based on the family size
• Employment expense allowance

This yields available income, which is just another term for discretionary income.

Definitions for Income-Driven Repayment

Income-driven repayment plans assess a portion of discretionary income as available to repay student loan debt.

The definition of discretionary income is simplified further in the formulas for student loan payments under income-driven repayment plans. Instead of subtracting various allowances from total income, the income-driven repayment plans define discretionary income by subtracting a multiple of the poverty line from adjusted gross income (AGI).

This table illustrates the four income-driven repayment plans for federal loans, which base loan payments on a percentage of discretionary income. Income-contingent repayment uses a different definition of discretionary income than the other income-driven repayment plans, basing it on 100% of the poverty line instead of 150% of the poverty line.

What is the Poverty Line?

The poverty line, in theory, is the income level at which the wage-earner has no discretion as to how they spend their income. The poverty line depends on the family size and whether the family lives in the continental U.S., Alaska or Hawaii.

For example, the poverty line for a family of one in the continental U.S. is $12,490 in 2019. 150% of this figure is $18,735. So, if the borrower‘s AGI is $40,000, the discretionary income will be the difference between AGI and 150% of the poverty line, or $40,000 – $18,735 = $21,265. The monthly payment under PAYE will be one-twelfth of 10% of this figure, or 10% * $21,265 / 12 = $177.21.

If the family size is four, the poverty line is $25,750. 150% of this figure is $38,625. Assuming the same AGI, the discretionary income will be $1,375 and the monthly payment under PAYE will be $11.46.

With lower income or a larger family size, discretionary income might be zero, leading to a zero monthly student loan payment.