Active vs Passive Income & Why One Is So Much Better

Active vs passive income: which one is better? It’s an important question, as these are the two primary types of personal income. 

Individuals can have one or both types, depending on their occupation and lifestyle. While one type may require more work, each has advantages and disadvantages.

But how do they differ? Below, we’ll compare and contrast active and passive income to help you better understand each one. 

And stick around till the end and we’ll give you a glimpse into how the best one can be started. And if you’re not the patient type, click here to jump there now!

What is Active Income?

Active income is earnings that you make from working either full-time or part-time. It’s “active” because you have to put in the effort to receive payments. It’s also known as “earned income,” and it’s generally earned from a job or some type of employment. But it can also be from self-employment, or owning a business or LLC.

For example, money generated from actively working as an employee, or self-employment in a business, would be considered active income. The same goes for working a traditional job. If you’re an employee, the money you make is active income because you work in exchange for a paycheck. You are trading time for money. 

While some earnings and types of employment may require little effort, most active income sources will require you to work actively and frequently to generate the money continuously. 

In most cases, that means a full-time job. This is where you are trading time for money. Once you stop working (putting in the time), the payments stop as well, unless of course your company or organization provides a pension. In that case, the payments continue after you stop working, but in 2023 that is becoming increasingly rare.

Examples of active income include:

• Wages from a job
• Commissions from sales
• Tips
• Profit generated from a business you actively participate in as an operator
• Freelancing
• Hourly Work
• Salary Work

What is Passive Income?

Passive income are earnings you make even when you’re not actively working. It doesn’t require your constant participation to generate earnings. Investopedia defines passive income as “earnings an individual derives from limited partnerships, rental properties, or any other enterprise in which he or she is not materially involved.”

In other words, money flows in without you having to do anything (at least not much) to receive it. It can come from various sources, such as investments, royalties, affiliate marketing, and even some side hustles.

But while it doesn’t require active participation, that doesn’t mean it’s easy money. In most cases, you need to put in a significant amount of upfront work before you start seeing returns.

Examples of Passive Income

For example, an author needs to write a book, an artist needs to record an album, or a product expert needs to create a course before he or she can start earning passive income in the form of royalties. This takes a lot of work up front while receiving no payment, but the payoff can be substantial.

Examples of Passive Income include:

• Affiliate marketing
• Ads on a blog or video
• Dividends from stocks and mutual funds
• Interest from savings accounts and bonds
• Rental income from property you own but don’t actively manage
• Royalties from books, songs, or patents
• Revenue generated from a business that you’re not actively involved in
• Gains from selling equity in a business or investment

Comparison: Active vs. Passive Income

There are many differences between active and passive income. The most obvious is that active income (a job) requires your time and energy, while passive income does not. But they are also interconnected in that one usually requires the other, at least to some extent.

For example, most people depend (in most cases) on earning an active income in order to obtain the capital necessary to create and generate a passive income. So you have to crawl and walk before you can run!

Passive Income Requires More Upfront Work

And while we may think of passive income as “easy money,” it often requires a lot of work up front before any money starts flowing in the form of passive income. The work and effort needed vary depending on the source of passive income.

Another difference is that active income is typically subjected to FICA taxes totaling 15.3%, and has limited opportunities for tax deductions. 

On the other hand, some passive income isn’t subject to FICA taxes and has more potential for tax deductions. For instance, with rental properties, you can claim repairs, maintenance, depreciation, mortgage interest payments, management fees, and property taxes.

Besides that, passive income has more potential for long-term growth. While active income is excellent for meeting immediate needs, it doesn’t offer much compounding returns over time. 

Active and passive income are both important sources of earnings. But they are pretty different and both have their pros and cons. Depending on your goals and lifestyle, one may better suit you than the other.