Active Income and Passive Income: A Simple (But Complete) Guide

There are two types of income: active income and passive income (some considers portfolio income as third type of income). Active income is income that you earn through work, such as a salary from a job. Passive income is income you deserve without putting in active labor, such as rental income from property you own.

Active Income And Passive Income

Both types of income are essential. Active income is significant because it is typically the primary source of income for most people. Passive income is substantial because it can provide you with a source of income even when you are not actively working.

Passive income can be a great way to supplement your active income and help you reach your financial goals. If you are interested in generating passive income, there are several things you can do, such as investing in real estate or investing in a business.

Active income and passive income meaning

Active income:

Active income is what you get from your full-time job or business. For example, suppose you work in a café. You show up to work, provide your services, and go home, and then every two weeks or so, you’ll get paid for your services; now, that’s what we call active income.

Passive income:

Passive income is income that you earn without actively working for it. For example, renting out the spare room of your house on Airbnb can be classified as a passive income.

The cool thing about passive income is that you can make money while sleeping. The fact is, you need to have both to be truly wealthy.

Active income and passive income examples

Active income is income that you earn from working. Wages, tips, commissions, and other forms of compensation are some examples of active income. 

Passive income is income that you earn without actively working for it. It can include interest from investments, rental income, and other forms of passive income.

Actively income is tough to generate because you need to find a job and work hard. Passive income is generated without active participation, without effort, or without a lot of time, but it requires finance.

Also Read: Money making tips for mommy

What is the difference between active and passive income?

As already discussed above, active and passive income are different. Let’s jot down some of the critical differences between active and passive income. 

1. Nature of income

Active income is earned through labor, such as wages from a job. Passive income is generated through investments, such as interest from a savings account or rental income from a property. 

2. Participation

The critical difference is that active income requires ongoing work to earn money, while passive income does not.

active income and passive income

3. Wealth Creation

It’s hard to create wealth from active income because you only make money from active participation. Passive income is a great way to build wealth over time because it does not require constant effort to maintain

4. Financial Independence

It can take longer to achieve financial independence through passive income alone than through active income. For this reason, it’s essential to have a mix of both types of payment to reach your financial goals.

5. Risk Factor

Both active and passive income can be volatile, meaning their value can go up and down over time. It is a risk factor to consider when deciding how to generate revenue. For example, someone who relies solely on passive income from investments may be at risk if the markets crash.

Similarly, someone who relies on active income from a job may risk losing their income if they are laid off. When considering how to generate income, it’s essential to weigh the risks and potential rewards of both active and passive income sources.

Difference between active income, passive income, and portfolio income

Active income = Wages, salaries, tips, commissions, and other forms of remuneration. 

Vs.

Passive income= Earnings from investments, royalties, and rental income. 

Vs.

Portfolio income = a Mix of both but more on the passive side.

What is portfolio income anyway?

active income and passive income

Portfolio income is generated through investments and includes interest, dividends, and capital gains. This type of income is vital to consider when creating a financial plan, as it can provide stability and growth. 

For example, if an individual has a portfolio consisting mainly of stocks, they may experience more volatile income than someone with a bond portfolio. However, over time, stocks have the potential to provide higher returns than bonds.

Therefore, it is important to consider both the short- and long-term when making investment decisions.

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Passive income vs. residual income

There are two types of income that you can earn: passive income and residual income. Passive income is income that you deserve without putting in any active work. It can include interest from investments, rental income, and royalties from intellectual property. 

On the other hand, residual income is income that you continue to earn even after you’ve stopped working. It can include royalties from a book or movie that you’ve already written or filmed or income from an established business.

Passive income vs. residual income- which is better? 

That depends on your goals. If you’re looking for a steady stream of income that you can rely on, passive income is probably your best bet. However, if you’re looking to make a lot of money in a short period, residual income might be a better option.

How is passive income taxed?

active income and passive income

If your primary source of income is an entirely passive investment, then it’s going to be hard to avoid paying tax on it. This has to do with a few things, including paying your taxes on your capital gains and then paying tax on your profits. 

If you have made a profit, you have to pay taxes. It doesn’t matter what kind of income it is or where it comes from. An excellent example of this would be if an investor were to invest in a stock and then profit from it. Any investment income will be taxed and will be considered active income. 

But, how much tax?

It will be taxed between 10 to 37 percent based on income and profit.

How to turn passive income into active income?

You can then use your active income to fund your passive income. For example, you can use your monthly active payment to pay your mortgage if you own a rental property. Then you’ll get money from your tenants. 

A professional writer might use his active income to fund his passive income. He could sell his ebooks and make some money that way or even get paid to write articles. Then he could use that money to pay for his seminars or continue researching his following ebooks.

I’m Hitesh with the simple finance website and like to talk a lot on financial subjects and how to save money. So, if you’re interested in this type of content, feel free to share the article and subscribe to our newsletter. 

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