What is the difference between active and passive income?
The usual notion of earning money is putting in your work hours and getting paid for it — easy enough to understand, right? However, looking at the bigger picture, there are two categories of generated income: active and passive. So which type are you earning right now?
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Active income vs. passive income
While it’s true that money isn’t everything, it’s a significant factor affecting how we live our lives. People need to earn an income to pay for their needs and desires, and to put it into their savings.
Between active and passive, which source are you pursuing? Learning the difference between active and passive income can help you build the financial stability you desire and live on your terms.
What is active income?
Active income is what many of us are familiar with, which is receiving money in exchange for performing a service. It requires active participation or action to earn money, hence the name “active income.”
Salaried jobs like working 9-5 in an office and hourly wages, whether part-time or full-time, are sources of active income. The same goes for commissions, tips, consulting or freelance fees, and the like.
Benefit: Active income is generally seen as more dependable, especially if you’re working a salaried or hourly wage job. The steady work converts to consistent cash flow, making it easier to predict your yearly income.
Drawback: Most active income jobs require devoting a majority of your time to work (for example, a 40-hour work week) to generate money. This leaves little to no time for the individual to pursue hobbies, travel, spend time with family, etc.
Taxes: Paying taxes on active income is generally an uncomplicated process, as it follows a straightforward system and the federal tax bracket.
What is passive income?
Passive income is earning money through profit-producing assets, which requires little to no active involvement from the individual. It is often described as “making money while sleeping” because even if you aren’t physically present, you’re still continuously making money.
However, to earn passively, you must put in the work first. Generally, acquiring revenue-generating assets requires a lot of time, effort, and funding (usually the money earned from active income). For example, you save up and buy a property, fix it, and rent it out to tenants. Their rental payment becomes your passive income.
There are various ways to earn passive income. To name a few: renting out a property or space, affiliate ads/marketing, digital advertising, licensing intellectual property, blogs, and more. Others consider portfolio income, revenue generated through investments, stocks, etc., a part of passive income.
Benefit: After the initial labor and financial investment you put into the asset, the passive income begins to flow in with little to no work needed. You can earn money while having time for yourself.
Drawback: It can take months or years to generate passive income based on the funding and time you need to complete the asset. Additionally, revenue might be inconsistent depending if the purchase is doing well. Thus income is less predictable.
Taxes: With the less steady nature of passive income, taxes can be more complicated, requiring the individual to study the IRS (Internal Revenue Service) regulations to determine the tax rate and deductions.
Active or passive: Which is better?
Both types of income have benefits, and choosing between them mostly depends on the individual’s lifestyle, circumstances, and financial goals.
Be that as it may, passive income is the more attractive choice as you can generate money and build your wealth while still having time for a million other things. In addition, passive income can be a stepping stone to a more flexible lifestyle and possibly financial independence if it all goes well.
Although residual income requires less time to work, let’s not discredit active income. On the contrary, a steady and regular source of money is a sustainable choice, not to mention that active income is often the financial foundation for a passive income asset.
Instead of choosing between the two, some people have both active and passive streams. Passive cash flow can supplement your earnings from an active income job, allowing you to save more to reach financial stability or for retirement.