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Knowing the various types of income is important.
Too many times we think of income just in one big lump category of “income.”
However, there are actually three types of income sources you need to know about.
Have you ever considered that?
Simply put… the more types of income you have, the greater your freedom.
If you want to become more savvy with your money, then keep reading. In the end, you may modify your money goals to widen your income circle.
Money and Freedom
Money doesn't buy happiness and it never will.
However, money gives you choices, which give you freedom.
It gives you the freedom to decide how and where you want to spend your time, what you want to do in life, and the chance to reach financial freedom. Or what we like to say… Money Bliss!
At each different type of income, each of them provide more and more freedom in life and with money.
You have the choice to decide how to spend and save income.
Types of Income Sources:
Today, we will break down everything you need to know about the various types of income sources.
Just to note… Tax law is constantly changing and this is a VERY high overview. So, please refer to the IRS website for current information. I do my best to keep up with the tax changes. But, this is not to be considered tax advice. Seek a professional for that.
1. Earned Income (Active Income)
This is the type of income most people consider when it comes to income. Also, most people never move on from earning active income.
They trade their time for money as in a paycheck.
Examples: Paycheck, salary, bonuses, contract work, wages
Tax Considerations: Earned income is taxed at the highest bracket of any type of income. Currently 10-37% for federal and 0-13% for state taxes. Plus this active income is subject to Medicare, Social Security, and possible state insurance taxes, which takes at least another 7.45% off your earned income.
Side note: Yes, I know that most people should benefit from Medicare and Social Security at some age. However, it is not something I personally plan on being available when my time comes. If it is, then I will consider it a bonus!
Active income is the most highly taxed type of income. From the start 17-58% of your hard-earned income is shaved off.
(Why yes, there is good things that come out of federal and state taxes like roads, fire and police protection, keeping our nation beautiful, and many more things. Taxes are an evil necessity in life.)
As you progress on your journey to financial freedom, remember the percentage of money that is taken away from your earned income.
Earned income is the what most people consider to be the norm and the easiest type of income to make. However, when you stop working, the income stream is cut off as well.
Related Reading: With the Right Money Mindset, Go from Broke to Rich
2. Passive Income
Passive income is cash flow (money) received on a reoccurring basis that involves minimal effort to maintain it. Money that is earned without you actively having to work for it.
A great example is rental property.
Examples: rental income, crowdfunding, affiliate marketing, online courses, books
Tax Consideration: Out of all of the types of income, this is the largest gray area under IRS code. There are many ways to handle taxes and expenses, so reaching out to a tax professional would be helpful. However, passive income has the best tax treatment of all of the different types of income.
Passive income should keep rolling in as long you have things set up.
The key to passive income is to not be actively working on it to maintain it.
If you are considering starting an online business or blog, I highly recommend checking out this beginner's courses to see if this type of work is a fit with you and your lifestyle. Want to take your business to the next level, then check out this mastermind group.
Best Passive Income Books or Courses:
- The Book on Rental Property Investing: How to Create Wealth and Passive Income by Brandon Turner
- Smart Couples Finish Rich by David Bach
- How to Invest in Real Estate: The Ultimate Beginner's Guide to Getting Started by Brandon Turner and Joshua Dorkin
- Blog Simple Framework
- Build a 6 Figure Business in 18 Months by Paul Scrivens.
3. Portfolio or Investment Income
This is non-passive income that earns money without any real work on your part (besides opening a savings account or investment account and not keeping the money under your bed).
The money you have saved and invested is working in your portfolio for you.
The best real life example for most people with portfolio income is your retirement account. Throughout the years, you slowly add money to the account, which receives dividends and interest and hopefully a rise in value. Then, at some point, you will live off your retirement account through portfolio income.
Examples: investments, dividends, capital gains, and interest
Tax Consideration: Much more favorable tax position than earned income. Portfolio income is taxed at a lower rate. Right now, it is dependent on your tax bracket and filing status and can be 0%, 15%, or 20%. Anything held for less than one year is still considered ordinary income, which is taxed at the same level as earned income.
The key is to hold your investments at least one year in order to qualify for the lower capital gain tax rates.
Many people throw out the idea of every actually earning money from investment income or a portfolio. However, you can start with just $50 and slowly add to your investment account. Read… How to Invest in the Stock Market – Beginner’s Guide.
Pick out one of the 52 week money saving challenges to get you started in saving money.
Best investing books; learn from the top gurus in the business.
- The Simple Path to Wealth by J.L. Collins
- The Little Book of Common Sense Investing by John C. Bogle
- Bogleheads Guide to Investing by Taylor Larimore, Mel Lindauer, Michael LeBoeuf, and John C. Bogle
- The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham, Jason Zweig, Warren E. Buffett
- Learn to Earn: A Beginner's Guide to the Basics of Investing and Business by Peter Lynch & John Rothchild
- UNSHAKEABLE by Tony Robbins
Income to Financial Freedom
Discovering the different types of income will uncover ways you can “earn” income without actively managing it. Ultimately, that will give you freedom.
The choice is yours.
Do you want to spend your whole life trading your time for a paycheck? Or do you want to move to passive or portfolio income?
The decision is yours.
The way you earn income is a shift in money mindset. Become knowledgeable in the other ways to earn income and then you can start moving your way out of actively earning income and maybe to financial independence retire early.
Hopefully, understanding the types of income has opened your eyes to the type of income you can “earn” without the time investment.