Disposable Income - What's left to our discretion?

The definition of disposable income according to Wikipedia is the total amount of income an individual makes after direct taxes.

Gross income - taxes = Disposable income

Discretionary income therefore is the amount after taxes, and after the cost of the fixed expenses of life (rent/mortgage, food, car payments, insurance, etc.), otherwise known as necessities.

Gross income - taxes - necessities = Discretionary income

In other words, it's income that can be saved or spent on goods and services that we want, as opposed to things that we need.

When applying for a loan or a mortgage, banks often take into consideration the applicant's disposable income in order to assess the loan repayment capacity of the applicant.

What's left to our discretion?

Recent news reports have highlighted that disposable income in the UK is at its lowest level for a decade. It seems that no matter how hard we work, the costs of living continue to rise; which makes one think that too much of our income ends up in the waste disposal and not enough is left to our discretion.

A price comparison website uSwitch claims that in 1997, when Labour came to power, people were left with 34.5% of their gross income once they had paid taxes, national insurance, mortgage or rent. Now they are left with only 32.6%.

The biggest salary swallowers highlighted in the table below relate to 4 key areas that have increased the most over the last decade.

(i) TAXES: Direct taxes linked to our salaries have shot up 81%, which some may argue results from a fair income graded tax system. Far less satisfactory however is the increase in indirect taxes (those that are not linked to our income) and in particular council tax rates which have increased by a whopping 92%.

(ii) HOUSING: The cost of a mortgage has more than tripled in 10 years which affects both home owners and tenants. This problem has been enhanced recently as many home owners are being forced to switch from a fixed rate mortgage to a variable rate, which with the increase in interest rates in recent years could come as quite a shock.

(iii) PHONE & INTERNET: Communication and information have become a huge part of daily life. As a result, related bills have risen 77%.

(iv) PETROL: A necessity for many people, the cost of petrol has risen by 55%.

Is it all doom and gloom?

There's no denying life has become more expensive, but we need to keep it in proportion.

According to the Office for National Statistics data, the RPI index increased by around 17.5 per cent over the ten year period in question.

In actual terms, a comparison between 1997 and 2007 shows that disposable income is as follows:

1997: 35% x £34,796 = £12,002

2007: 33% x £53,895 = £17,530

This means an increase of 46%, which when compared to inflation shows a fairly healthy step up in actual disposable income.

Having said that, the increase in costs will affect a lot of people at a time when there's been a noted increase in the number of households living below 60% of the average household income. Ultimately, each of us needs to assess our personal situation and take steps to manage our outgoings in relation to our income.

Keep an eye on our blog, we're planning to issue advice on personal finances and saving plans in the next few weeks, aimed to help with bill management.