In here we share with you the differences between Active Income and Passive Income. Passive sources of income may include money generated from interest and dividends on investments, limited partnerships, and rental property. Likewise, salary, hourly wages, commissions, and tips are examples of active sources of revenue.
One can have one of these income sources or both of them to enjoy financial freedom and lead a desired lifestyle. Passive earning is a better choice than active one in terms of practicality, but one must have a regular source of money to earn passively.
In this article, we’ll discuss the pros and cons of active income and passive income.
Table of Contents
- What is Active Income?
- What is Passive Income?
- What’s the difference between passive income and active income?
- Benefits of passive income
- How Passive and Active Incomes are Taxed
What is Active Income?
Active income is defined as salary earned from specific duties or services rendered according to an agreed task, within a specified time frame.
Examples of active income are salaries, tips, fees, commissions, and allowances from the companies you provide services to. If you’re working for a person or a company–be it manual labor, office work, or home-based service–you earn active income. You can even be working for yourself, which is called being self-employed.
Active income earners are also either full-time, part-time, freelancing, or contractual workers. It is the most common type, if not the only type of income for most Filipino households.
Payment for active income earners happens every two weeks (colloquially called “kinsenas” or paid every 14 to 15 days). Some do get paid daily, weekly, once every month, or paid per project.
Another way a person can earn active income is by selling a product. Such is the case for artists, bakers, chefs, and tailors.
Having regular active income has distinct advantages. For one, it is more predictable and secure if you’re trying to budget your monthly expenses. It also comes at expected periods, so it is easier for you to save and plan.
However, a regular active income comes with challenges too. For one, it might not be enough to cover your living expenses. It could also be too meager for you to build an emergency fund.
Another challenge active income earners face is the reality that they cannot possibly provide certain duties or services their entire lives. It just is not humanly possible.
What is Passive Income?
Income that requires little effort to maintain is passive income. It can be additional income from a rental property, the stock market, or a company that you are not actively involved in.
Passive income is often described as “making money while you sleep,” but there’s more to it than that.
If it really was that easy, everyone would be counting dollar bills while also counting sheep. If you have enough money, you can buy assets like an Airbnb rental property, cryptocurrency, and stocks that make money on autopilot. But what happens if you don’t have the funds to get started?
The answer for many creators and bloggers is to make the assets themselves. Larger assets, like property, involve investment capital that not everyone has, but creating assets yourself requires your time and effort as investment, so you can reap the rewards later.
If you’re willing to get paid absolutely nothing while you build up your passive income strategy, it can be an amazing long-term revenue stream and a consistent cash flow.
Passive income comes in two main forms. Each one provides a different way to generate income, and they can be used individually or in tandem, depending on your financial goals:
- Creating. Money earned from doing the work upfront. Examples of passive income include selling digital products, writing books, creating music, or making another product that earns cash.
- Investing. Money earned from investing in assets. It usually requires an initial investment and can include dividend stocks, real estate investment trusts, renting out a spare room or leasing, interest, capital gains, peer lending, mutual funds, and royalties.
What’s the difference between passive income and active income?
The main difference between active income and passive income is that active income is earned through effort or output. In contrast, passive income requires upfront work.
Both active income and passive income require work, it’s just a case of when that work happens. Someone paid by a brand to write blog content every month is generating earned income, while someone who writes 20 blog posts upfront for their own site and monetizes them with affiliate links is generating passive income.
Earned income is the traditional income model because it doesn’t have as many risks. The concept is simple: you do the work you know you’ll get paid for. Passive income is a good side hustle for creators and social media influencers with full-time jobs or other responsibilities who want to continue building their brand.
Benefits of passive income
1. You Have More Financial Stability
Many young people struggle to achieve financial stability. They’re left living paycheck to paycheck just so that they can make ends meet.
When you have passive income, you can count on earning money without having to work for it. That means that you’re able to achieve financial stability much faster because you know you have a financial safety cushion.
2. You’re Not Reliant on a Paycheck
Like we mentioned earlier, many people rely on their paycheck to pay rent and other bills each month. If their paycheck is lower than normal due to vacation or sick time, it can cause problems.
When you make passive income, however, you don’t have to worry about this. You know that you’ve got extra income from passive income on the side that can help you out in a pinch.
3. You Can Meet Your Goals More Easily
While money can’t buy everything, it can certainly buy a lot. And, when you have passive investments, you have more money at your disposal.
That means that you’ve got more spare cash to put aside into savings to help you save for big purchases such as car, house, or tuition payment. In other words, your passive income helps you meet your goals faster!
4. You Have More Financial Freedom
When you rely heavily on your paycheck, it’s tough for you to take time off work to pursue your passions. Instead, you’re forced to work long hours to make sure that your paycheck is consistent.
When you have passive income, however, all that changes. Suddenly, it’s much easier for you to take time off to follow your dreams. You can afford the time out of the office knowing that you’ll still be making money.
5. You Gain Location Independence
Have you ever thought about how magical it would be to lounge on a beach and still make money? After all, we see famous influencers doing it all the time!
When you don’t have to constantly be at work, you can start traveling the world and still earning money. Passive income gives you the freedom to work and live where you like!
6. You Can Retire Early
Retirement is something that many people look forward to. However, if you’re living paycheck-to-paycheck retirement is probably off in the distant future.
With passive income, you can start saving for retirement sooner. That lets you retire earlier and enjoy your golden years!
How Passive and Active Incomes are Taxed
Like with anything money related, the Internal Revenue Service (IRS) has something to say about active income and passive income.You still need to understand and abide by local income tax laws:
- Know how the IRS defines passive income. Passive income is defined as either “net rental income” or “income from a business in which the taxpayer does not materially participate.”
- Know what counts as “material participation.” The IRS has a set of guidelines for what it calls “material participation” that determines whether someone has actively participated in business or other income-producing activity.
- Know when passive income is taxable. Hint: It always is. It’s usually taxed at the same rate as salaries, but it can receive different treatment from the IRS.
Active income and passive income are interconnected. The more you earn in terms of active income, the more you can invest to earn passive income. Besides this, you can invest more aggressively in passive sources of income if your active income more than covers your regular expenses. Of course, this assumes you have an emergency fund so that you don’t have to source money in the event of a sudden expense.
On the other hand, the more you earn from passive income, the more you can afford to take risks with your career, and possibly move to a more lucrative job.
Alternatively, the more you earn from your passive income, you might be able to take a job that pays less but is more aligned with what you want to do in life. In fact, one financial goal you can set is to earn so much from passive income that you can afford to work for fulfillment instead of money.
All that being said, an understanding of the differences and relationship between active income and passive income can help you chart out your life in terms of finances. One might give way to the other. Having both active income and passive income sources of income open up possibilities and opportunities for you.
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