What is Disposable Income

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Calculating and Understanding Your Disposable Income

"Disposable income" is a concept that you've probably come across when reading about economics, personal finance and debt. The term refers to the after-tax income of an individual or household. Understanding your disposable income is important when setting budgets, planning investments, determining child support or when faced with a possible lawsuit over debts.

What Does "Disposable Income" Mean?

In economics, disposable income refers to household income after deducting mandatory taxes, such as state and federal income tax, Social Security and Medicare. Another term that you might often see is "discretionary income," which refers to household income after paying for necessities, such as food, housing costs, insurance and utilities. It's important to note that the boundary between mandatory and voluntary deductions is quite strict: Even though you may consider deductions made for health insurance and your 401k to be essential, they are still considered as optional expenses because you choose to have insurance coverage and a retirement plan.

How does Disposable Income Relate to Wage Garnishment?

If you owe a debt and have not been able to pay it, a creditor may attempt to garnish your wages. Also known as "payroll garnishment," your employer will receive an order from a judge or administrative body to deduct a percentage of your pay each pay period to repay your debt. There are limits on how much of your wages can be garnished, however. These limits are established by both federal and state laws; and state laws may prescribe limits that are lower than what federal law dictates.

In addition, federal and state laws also offer guidelines on reducing garnishment levels even further for low-income individuals. Some types of income, such as child support, Supplemental Security Income (SSI) and unemployment benefits, may be immune from garnishment for most debts. However, if your debt includes student loan balances, back taxes or child support, these limitations may not apply.

Here are some examples:

• Federal student loans: Federal law stipulates that no more than 15 percent of your disposable income can be garnished to repay federally guaranteed student loan debt.
  
• Court judgments: Wage garnishment limits for most debts, including student loans from private lenders, is 25 percent.
• Child support: If you are in arrears on child support, the amount of disposable income subject to garnishment ranges from 50 to 60 percent, sometimes more.

Using Disposable Income to Calculate Child Support

Courts use disposable income levels as one of the factors in determining child support payments. Each state has its own formula, however, and judges consider multiple factors, including a parent's earning potential, when setting support payment amounts. Your lawyer can help you understand the law and the process in your state.

Defining Disposable Income in Chapter 13 Bankruptcy Plans

If you are filing for Chapter 13 bankruptcy, the term "disposable income" has a different meaning. In Chapter 13, you are permitted to keep your property and assets and instead agree to enter into a long-term debt repayment plan, supervised by the bankruptcy court. The repayment plan requires you to apply all your disposable income, as defined by bankruptcy law, to debt repayment. Your disposable income consists of money left over after taxes, priority and secured debts, and household expenses. A bankruptcy attorney can assist you in developing a budget that meets plan requirements while also providing you and your family with enough income to live on.