Passive Vs Active Income

Money earned comes from either active income or passive income. Most of us have heard about the two but may not know the differences between passive vs active income.

Whether you believe the way to financial freedom is by getting out of debt or building passive income, we can all agree that having more income would be helpful. To that end, this article will go over the pros and cons of both active and passive income.

Passive income is income earned more than once from past efforts of work done, most often from real estate or business income, though can also be from many other sources. Active income is money you earn from the active work you do, most often a job, and is not received more than once.

What is active income?

Active income is what you earn at your job, selling stuff you no longer need, or flipping products on eBay or Amazon and the like. Think single sale income without any chance for repeat income. At the start of a new day, week, and month you are starting from zero all over again.

This is basically what is referred to as being in the rat race. You spend all your time trying to make a paycheck and then start all over making a paycheck come the next pay period.

Active income can be earned from being self-employed, as an employee, and even as an investor or business owner. In Robert Kiyosaki’s book Rich Dad Poor Dad he refers to these as the four quadrants of income.

Most people that start working in the investor and business owner section do so with the goal of generating passive income. To a degree, you can do so while self-employed as well.

Turning active income into passive income

For most individuals, you’ll have to continue your active income position and use a portion of it to start a passive income option. Many individuals start with real estate simply because it only takes a couple of hours a week to begin and has really good passive income when put into place.

Creating passive income often requires either time or capital to create. The more capital you have to put into it the less time required to generate.

What is passive income?

Passive income is income that keeps coming in over and over again with little to no additional work required. For those in retirement, they understand what this is like if they have a pension or an annuity because the income is guaranteed for a period of time on a regular basis, usually monthly. No more work is done, they just get a check at the same time every month.

The type of income-producing asset you use to create passive income for you depends on your goals and personal interests. Some people may love writing so they create a blog. While others just want the residual income so they get involved with real estate investment trusts so there are no landlord requirements and purely get monthly income as a silent investor.

Can you combine and do multiple things? Absolutely. In fact, most wealthy individuals have multiple sources of income. Most have a diversified system, though it is usually all within the same business.

Benefits of passive income

Active income is what I consider to be survival income. You earn it to buy your essentials like food, shelter, car, etc. However, there is no long-term wealth-building being done with it. In order to create true financial freedom or wealth, you need to put together a strategy for building a passive income. Here are some benefits you can expect from doing so.

This article talks about some common retirement lies– check if you are making some of these mistakes.

Financial certainty

Building passive income creates financial security because it is near-guaranteed income on a regular basis. While you think having a job is guaranteed income as long as you go to work, what happens when you get sick and don’t have sick time? What happens in an economic downturn, is your job still secured?

In states that are at will, people can be let go for no reason or advance notice. How many people lost their jobs during the 2008 downturn? How many lost jobs due to covid? Your job is only as guaranteed as there is a demand on the employer for the work you do.

Passive income helps generate an ever-growing, guaranteed income stream to pay your bills and grow to an infinite scale if desired. One passive income system you could create looks something like: take capital and purchase annuities for 20 or 30 years of income, buy real estate for monthly rental income, refinance the real estate to buy more, and shelter a portion of your income in life insurance to reduce the tax rate and leverage it to buy more passive income creating options.

Stay within budget

Imagine having a certain amount of income come in every month like clockwork. You could stay within your budget, save money for emergencies, and put some aside for investing or other creative projects.

I’m sure you’ve heard it said that many are living paycheck to paycheck and if an emergency happened they wouldn’t even be able to handle a $600 problem that came up. This often happens because we aren’t living within our means.

Specifically means that most of us spend far more money on entertainment and other expenses that put our monthly budget near its cap. If you constantly spend everything you earn, then of course you won’t be able to handle emergencies.

Having passive income allows you to consistently stay within your budget by knowing you will have the money each month for the major bills. It also helps you to slowly pull yourself out of the whole of robbing peter to pay paul with credit cards or other expenses.

Get out of debt

One of the biggest goals most people have is getting out of debt. The challenge I see with this idea is that there is always a need or desire to get back into it. Instead of being focused on getting out of debt, how about focusing your efforts on increasing your monthly cash flow so that the expenses you do have, are guaranteed to be covered.

As you then add more income to your bottom line you can start removing the debt that doesn’t do you any good and restructure your finances. What would an extra $500 a month do for you? Another $5,000 for you or your business?

Improve credit score

With passive income, you can make your credit score increase, which will allow you to reduce the interest rate on your mortgage, get better rates on all loans and credit cards, etc. This alone can help you save hundreds of dollars a month if not more.

Credit scores are a really big factor in how much you pay when you do purchase those new cars, houses, or other items.

Tax benefits

Building passive income is great because there are many different tax breaks available to those buildings say a real estate portfolio (check with an attorney and accountant for details).

In addition to the tax benefits of real estate investing there are benefits to products, you can use to accelerate your passive income growth. Life insurance for example is tax-advantaged, or tax-free with the proper utilization of it. Also building capital through crypto or stock sales as a side project is taxed differently than wp2 income.

Buy with cash

Something I’ve heard a lot is “If you can’t pay with cash, you don’t need it”. With this in mind think about your own situation. How often do you buy things on credit just because you want something new, only to somewhat regret that payment over the next few months. Even worse is when something happens and you have to get a new transmission or water heater, something big that goes on credit also making your income really thin for the next year or more, all because you’re simply trying to get out of debt.

Summary

The differences between passive vs active income are simply in how much work you must continue to do. Passive income requires almost all work done upfront but offers income ongoing while active income requires constant effort to keep earning.

If you want to get out of debt, build large savings, or have other financial goals you are working towards reach out to us to help you improve your results with a custom game plan.