Income is the amount of money that a person or a business receives in exchange for providing a good or a service, or through investing capital. Income is used to fund day-to-day expenditures, as well as to save and invest for the future. However, not all income is the same. There are different kinds of income, depending on the source, the nature, and the taxation of the income. Here are some of the main types of income:
Earned Income
Earned income is the income that a person receives from working, either as an employee or as a self-employed individual. Examples of earned income include wages, salaries, tips, commissions, and business income. Earned income is usually the main source of income for most people, and it is subject to income tax and payroll tax (such as Social Security and Medicare tax) in most countries. This is often the kind of income that requires the most effort, but is also able to provide a bigger amount of earnings.
Passive Income
Passive income is the income that a person receives from sources that do not require active involvement or participation. Examples of passive income include interest, dividends, royalties, rent, capital gains, and income from certain businesses that do not require the owner’s direct involvement. Passive income is often considered a desirable source of income, as it can provide a steady and consistent cash flow without much effort or time. However, passive income is also subject to income tax, and sometimes at a higher rate than earned income. Passive income is also hard to build as it entails acquiring capital first. Earnings are also usually affected by how much capital is invested.
Portfolio Income
Portfolio income is a subset of passive income that a person receives from investing in financial assets, such as stocks, bonds, mutual funds, exchange-traded funds, and derivatives. Portfolio income mainly consists of interest, dividends, and capital gains. Portfolio income can provide a source of income that is independent of the performance of the economy or the labor market, and it can also offer diversification and risk reduction benefits. However, portfolio income can also be volatile and unpredictable, depending on the fluctuations of the financial markets. Moreover, portfolio income is subject to income tax, and sometimes to additional taxes, such as capital gains tax and dividend tax.
Residual Income
Residual income is another subset of passive income that a person receives from creating or owning something that continues to generate income after the initial work or investment is done. Examples of residual income include royalties from books, music, or patents, income from licensing a brand or a franchise, and income from network marketing or affiliate marketing. Residual income can provide a source of income that is scalable and sustainable, as it can grow over time and does not depend on the amount of work or input. However, residual income can also be challenging and competitive to create and maintain, as it requires creativity, innovation, and marketing skills. Furthermore, residual income is subject to income tax, and sometimes to additional taxes, such as self-employment tax.
Other Income
Other income is any income that does not fall into the above categories, or that is not derived from a regular or predictable source. Examples of other income include settlements, awards, bonuses, and others. Other income can provide a source of income that is unexpected and additional, as it can supplement the existing sources of income. However, other income can also be irregular and unreliable, as it can vary in frequency and amount. Additionally, other income is subject to income tax, and sometimes to additional taxes, such as gift tax and estate tax.
The Recommended Strategy
Earning from multiple income streams is important to help you achieve financial freedom. Ultimately you need to understand that different stages of your life will call for receiving more of a certain kind of income. For young people, earned income usually helps you build your wealth the fastest as you can make the most out of skills you learn. As you grow older, more and more of your income should come from more passive sources to ensure that you’ll fare well into your retirement years.
