Your discretionary income is:
What is Discretionary Income?
Generally speaking, discretionary income refers to the portion of an individual or family’s income that is left over after accounting for obligations and necessities such as taxes, food, and housing.
When it comes to federal student loans, discretionary income is also an important metric in determining borrowers’ monthly payments under income-based repayment plans. But, as you may have already noted, expenditures on things like food and housing are likely to vary widely according to geography and personal preferences, among other factors. So, the federal government provides a single method, which takes into account household size and state of residence, by which discretionary income for all borrowers is calculated.
To calculate borrowers’ monthly payment obligations under income-based repayment plans, the federal government uses the following formula:
Each input is explained below.
Adjusted Gross Income
In the US tax system, adjusted gross income (AGI) is an individual’s total income minus specific deductions. Deductions help to reduce the total amount of income subject to tax, and there are numerous reasons you may be eligible for one, including making payments to cover interest on student loans.
You can locate your AGI by looking back at your tax documents:
- On the Form 1040, AGI is located on Line 37
- On the Form 1040A, AGI is located on Line 21
- On the Form 1040EZ, AGI is located on Line 4
Other Measures of Income
If you didn’t file an income tax return for the previous calendar year or if your income has changed significantly since you did so, you can use your current income to calculate your discretionary income.
Note that if you proceed to file an application for an income-based repayment plan, your loan servicer will require you to provide documentation of your income. Typically, you’ll be asked to document any and all income from employment, unemployment benefits, dividends, interest, tips, and alimony.
The Federal Poverty Guidelines
The federal poverty guidelines are the second component of this equation, and they’re used to estimate costs of associated with a minimum standard of living in the United States. Each year, updated guidelines are issued by the Department of Health and Human Services.
The poverty guidelines include built-in adjustments for household size and, to some extent, state of residence. That is, the poverty level is higher for larger households and for residents of Alaska and Hawaii, where the cost of living is generally greater than it is in the 48 contiguous states.
What Isn’t Factored Into Discretionary Income
The federal poverty guidelines are used to estimate the cost of maintaining a minimum standard of living in the United States for the purposes of determining eligibility for certain federal programs. However, they’re not perfect, and there’s a lot that they fail to capture.
For one thing, there’s a lot of variability in the cost of living across the 48 contiguous states. Residents of large cities like Boston and San Francisco, for example, will inevitably spend more on food and rent than many of their counterparts throughout the country. The poverty guidelines treat everyone the same.
Additionally, things like medical expenses won’t reduce your discretionary income, at least until they exceed 10 percent of your adjusted gross income for the year. At that point, the IRS allows taxpayers to deduct qualifying medical expenses.
How Discretionary Income Impacts Your Income-Based Repayment Plan
Discretionary income is used to calculate borrowers’ monthly payment obligations for federal income-based repayment plans:
- Under REPAYE and PAYE, borrowers are typically required to make payments equal to 10 percent of monthly discretionary income.
- Under IBR, borrowers are typically required to make payments of 10 to 15 percent of monthly discretionary income, depending on when the loans were taken out