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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.
Personally, this has been something I have taken seriously over the past year. It was quick to realize the outside influences have on our income. So, we made the conscious decision to develop different income sources.
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 source circle.
Money and Freedom
Money does not 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.
Plus the best part of having 3 types of income, you gain time freedom and that is priceless.
Are you ready to learn what are the three types of income?
Types of Income Sources:
Have you ever considered what are the three different types of income?
Most people don’t even think twice about it, but these are the types of income sources that need to be considered for long-term financial success.
Today, we will break down everything you need to know about the various types of income sources and their definition.
You will use all of these types of income to come up with your annual income.
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 during their slow season.
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.
Benefits: This is the easiest income source to earn.
Drawbacks: By definition, earned income typically has a limit of earning potential. Also, it is the highest-taxed source of 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. That is how you find your annual net income.
(Why yes, there are good things that come out of federal and state taxes like roads, fire and police protection, keeping our national parks beautiful, and many more things. Taxes are an evil necessity in life.)
Did you know how much $15 an hour goes to taxes? Your hard-earned cash is used up for other things that you do not have an opinion on how it is spent.
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 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: $60000 a Year is How Much an Hour? Good Salary or Not?
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 a 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 the 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. Plus you can have as many businesses as you want. One, two, three, or four – it all becomes what you can manage.
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 these 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.
Benefits: You earn money without trading time for money. This is the biggest benefit of passive income. You already put in the hard effort and now continue to earn money passively.
Drawbacks: Many people get terrified about the idea of starting their own business. There is more paperwork to be filed with taxes as well as at the state level. But, that should not distract you for the additional income.
Possible Passive Income Ideas:
- Learn How to Resell Items with Flea Market Flipper
- Start Freelancing Writing on the Side
- Learn to Sell Printables on Etsy or Shopify
Best Passive Income Books:
- 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
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.
Honestly, it is best to take a course with live video to help you truly understand how the stock market works. Here are my favorite investing courses, while they may be costly upfront, you will save money by not having thousands of dollars of losses.
Examples: investments, dividends, capital gains, and interest
Benefits: Your money is making money. Once you are on autopilot with your investments, you are able to enjoy the dividends or increase of net worth.
Drawbacks: The biggest drawback keeps most people out of the stock market. They are too afraid to lose money. Thus, they sit on the sidelines and lose money due to inflation.
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 for at least one year in order to qualify for the lower capital gain tax rates.
Too many times people shy away from learning how to invest money. If that is you, then you need to check out 45+ Personal Finance Experts Share The Best Ways to Invest Money!
Many people throw out the idea of ever 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 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 Discplined Trader by Mark Douglas
- 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.
You need to learn about time freedom and adopt this fresh concept to your life!
When you look to add additional types of sources of income to your portfolio, a shift in money mindset needs to happen as well. Become knowledgeable in the other ways to earn income besides earned income and then you can start moving your way to increase your income sources and maybe to financial independence retire early.
Hopefully, understanding the 3 types of income has opened your eyes to the type of income you can “earn” without the time investment.
Jump on the bandwagon with me and learn how different types of income can change your financial picture.