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Get in the Know on Income: The 3 Types of Income

November 19th, 2018 | By Ana Elliot

It’s hard being an adult right now – especially for those of us for whom it’s relatively new. We need employment, and for that we need experience and education. Educations cost us money. Housing costs money. Food… Bills...Everything costs us money! So, getting a handle on finances is a big deal. And sometimes all we have to fight against these costs, these constant monkeys on our backs is an installment loan!… er, we mean, income!

But do we truly understand income? I mean, really? Until recently, I thought it was just one thing: the paychecks or tips we get from our jobs. Easy peasy, lemon squeezy. You do a job and then get the pay.

Except that isn’t just it. There are different types of income. Yeah, you read that right: different types of income. But what are they? How can you benefit from them? Well, we can help with some of those questions!

Active Income

Active income is the type you are probably the most familiar with. Also called “earned income”, it is the one we get when we go into work and do a job or service then get paid. This includes salaries, wages, bonuses, and contract work. One of the things to keep in mind regarding active income is that it has the highest taxes of all the different income types we’re going to go over. You pay income tax plus Medicare and Social Security taxes on your active income. As such, it is often hard to “get rich” off your active income.

For most of us, our active income jobs just serve to make life possible. It pays the bill and allows for eating out sometimes. What we save here is often dependent on how much we make versus the cost of living in the area we live. You are also limited by the number of hours it’s possible to work. Active income requires you to “be working” which means you will never make more than the hours you actually work. This can put a damper on any get-rich-quick plans you were fostering. This also means you don’t get paid for time you don’t work (excluding PTO, of course). If this feels like a limiting form of income, have no fear. If you take some of your active income, you could turn it into a different type!

Portfolio Income

What is a portfolio and how do you get income from it? Well, portfolio income is income gained by selling an investment for more than you paid for it. Now, you might immediately jump to “trading stocks” when we say “investment” but stocks, bonds, and mutual funds are not the only kinds of investments you can sell for portfolio income. It also applies to more concrete items such as real estate or a vehicle. As far as taxing on portfolio income goes, it depends on how long you’ve owned the investment. If it is less than a year, then the sale or trade will be taxed as earned income but if it is for over 12 months, then you will be taxed 10-20%. The good news is you won’t be taxed for Medicare or Social Security on portfolio income. This method is also not a quick fix. Most of the time, to turn a profit, you have to buy the item and sit on it for quite some time to get any real profit. Trying to flip it for a profit too fast can be a gamble, so be careful!

Passive Income

Ah, passive income: this one is the dream. Passive income is income that comes… well, passively. What that means is that this is income that comes from your investments without doing anything further (including trading). This could mean rental income or business income (such as owning a franchise that has other people running it) as well as sales of intellectual property (like royalties from books or music) for instance. For those of us that dreamt of being famous novelists or musicians as young children, this was the income of our fantasies. We did one thing and then that one thing paid us for a while without any further work. Passive income is also the best income as far as taxes go. The issue here is that getting into passive income territory isn’t easy. Getting income off of investments takes careful planning and you often need to hire someone to help you figure out how to go about it. In this respect, active income is easier to get a hold of and deal with, despite not being the best long-term solution for wealth.

Well, hopefully this post has broadened your concepts of income and whet your appetite for greater income diversity. If you are interested in investing in real estate, check out this article we wrote a while ago. Or, if you are looking for something a little more general about investing, try this article on for size.