Personal Income

What is Personal Income?

Personal income, as the term suggests, is the gross total income received, for the period, by a person or household which includes all the sources of income being any compensation received, salaries and wages, income earned through investments made such as dividends, interest income, variable pay, performance pay, employer contributions towards retirement or pension plan, rental income and also any profits from the business. Alternatively, personal income can also be referred to as the before-tax income of the individual or household.

Formula

It is basically the Sum total of income received from all sources by individuals or households.

As discussed above, personal income can be calculated in either of two ways. The first method is by adding up all income received by the individual or household for a period. The other method is adjusting the national income with the income received but not earned and income earned but not received.

Personal Income = Salaries and Wages + Dividends + Interest + Bonus + Employer Contributions Towards Retirement Benefits + Rent + Profits + All Other Source of Income

OR

Personal Income = National Income + Income Received but Not Earned + Income Earned but Not Received

Explanation

• At a micro-level, It is defined as the sum total of gross income received by the individual or gross income received by a household from all sources combined. To elaborate, household income shall mean the combined gross income, from all sources, of all the individuals in a particular house.
• At a macro level, personal income refers to the combined gross income of all households taken together in a country. In other words, to arrive at personal income at a national level, one needs to consider gross total income received by all households from all sources such as compensation, interest, bonus, dividends, any social security benefits, etc.
• Personal income at the national level helps in understanding gross domestic consumption.

Examples

Let’s take an example to understand the calculation in a better manner.

Let us take the example of Julie. Julie worked at a nearby restaurant and was paid wages at a rate of $20 per hour. She worked for 40 hours a week. Apart from this, Julie also distributes newspapers in the morning, for which she gets paid $50 a month. Julie has a fixed deposit of $10000 on which she earns interest at a rate of 8% per annum. Julie receives a nominal amount of $45 every month from her parents to help her in pursuing higher studies.

Solution:

• In order to calculate Julie’s income, we will have to first find out her annual income from each source of income.
• Julie receives wages of $20 per hour and works 40 hours a week. Thus, she earns $800 (i.e. $20 * 40) per week. Therefore, she receives an annual wage of $41,600 (i.e. $800 * 52 weeks)
• Julie also receives income by distributing newspapers amounting to $50 per month. Thus, she earns $600 annually (i.e. $50 * 12 months)
• Julie receives interest on the fixed deposit she has made of $10,000 at an 8% annual interest rate. Hence, she is in receipt of interest amounting to $800 annually on the fixed deposit
• Lastly, Julie receives $45 from her parents on a monthly basis with respect to her education.

The amount for Annual Income is calculated as:

It is calculated as:

Combining the income from all sources, Julie’s personal income for the year is $43,540.

Components of Personal Income

It includes all the income received by the individual or household in a particular period. There can be varied sources through which the individual or household receives any income.

• Salaries and Wages: Compensation received from the employer towards services rendered
• Employer contributions to 401K: Contribution by the employer for employee’s retirement benefits
• Bonus: Variable pay received for services rendered in employment
• Profits: Profits received in business and distributed to owners
• Interest: Interest can be received on saving bank, fixed deposits, a loan given, investments, etc
• Dividend: Received on the investment made in the equity of a company

How to Calculate Personal Income?

In order to calculate the Personal income of an individual or a household, collate the first-hand details of all the income earned by the individual or household. The income received through all the sources, direct or indirect, totaled together provides us with the amount of personal income of the person or household. Direct sources of income can be explained as salaries and wages, performance pay, profits from business, and similar incomes. Indirect sources of income mean income by way of interest, dividends, or any miscellaneous income, which is not related to the main / core business or profession.

Alternatively, personal income can also be calculated as a factor of adjustment to national income. National income adjusted by the income received but not earned and income earned but not received shall also provide us with the amount of personal income.

Why is Personal Income Important?

• Personal income is basically the gross income of a person or a household. In other words, it depicts the purchasing power of the household.
• It is used to arrive at gross domestic consumption and consumer price Index at the national level. It is used in analyzing various economic factors such as marginal propensity to consume, marginal propensity to invest, consumption patterns, and trends on change in household income.
• Thus, it is a very important aspect from the point of the nation of view wherein it provides a picture of the purchasing power of households in the country and the reflective changes in economic factors.
• Also, huge differences in the personal income of various households can throw light on economic disparities within the economy and can be a cause of concern in the long-term growth of the nation.

Advantages and Disadvantages of Personal Income

Below the points explain the advantages and disadvantages:

Advantages

From an individual eye-view, personal income can be useful in the following ways:

• Personal income also referred to as gross income before tax is important from a tax perspective, and brings ease to income tax calculations.
• Individuals to have a better idea of what is his annual gross income or of their household.
• It can be used as a starting point to know the disposal income of the household.

From a nation’s eye-view, personal income can have the following uses:

• It provides information on purchasing power in the economy.
• It is used for measuring various economic factors with regard to purchasing power and consumption information.
• It helps in analyzing the trends and relations in changes in personal income viz a viz the spending habits of people.

Disadvantages

Personal income does have its own set of limitations. A few of them are mentioned below:

• It measures only the income received. It misses capturing the income which may have been earned but not received by the individual, for eg. Undistributed Profits of a company in which a person has invested
• Any income generated through the rolling of black money. Personal income does not account for income received unofficially.
• Laborers or Seasonal workers receive wages that do not have a fixed income. They receive wages only occasionally when there is work and would not be keeping a systematic record of income received.
• Any income received outside the country and taxed in the contracting state. Similarly, any income earned by a non-resident on the investment made in the country but taxed in his home country.
• Any income not disclosed in order to avoid paying taxes.
• Any barter trade wherein only exchange of goods or services is involved. In the absence of any monetary transaction, the income may not get recorded.

Conclusion

Personal income is the gross total income received by an individual or household. It includes income received from each and every source for all the individuals in a household taken together. It reflects the purchasing power of the individual or household, as the case may be. From the individual’s point of view, it provides him with a picture of his household income and what is the annual gross earnings of such individual/household. From a macroeconomics point of view, a higher personal income depicts a higher purchasing power, which means there will be a higher amount of money rolling into the economy and thus indicating a better future growth prospect.

Recommended Articles

This is a guide to Personal Income. Here we discuss how to calculate Personal Income along with practical examples. We also provide a downloadable excel template. You may also look at the following articles to learn more –

1. How to calculate Taxable Income?
2. What is Gross Income?
3. Example of Residual Income
4. Calculate National Income Formula