Passive Income vs Active Income

An income is money one receives after providing a service or after investing. Passive income and active income are some forms of income. Many people use passive income and active income interchangeably, but the two are different. In this article, we will define passive income and active income and list the differences. 

First, you need to know what is active income and passive income.

What is Passive Income?

A passive income is a form of income one receives from income-generating assets or investments without active involvement. You don’t have to spend lots of time in a day to generate a passive income. Passive income is established through savings from active income sources like salaries and wages.

However, at first, you need to dedicate time and effort to build a passive income source, but once it is established, active involvement is not necessary.

What is Active Income?

Active income is some form of income generated from salaries, hourly wages, tips, and commissions. You need to dedicate a lot of time and effort to generate an active income. It requires your involvement in that you need to perform some tasks related to your job or career.

Differences Between Passive Income and Active Income

The following are the differences between passive income and active income.

1. Involvement

To generate an active income, you need to dedicate a lot of time and effort in a day. You need to perform some tasks related to your job or career to generate an active income. If you stop working, you stop earning active income.

To generate a passive income, you don’t need active participation. You also don’t need to dedicate a lot of time. Passive income sources can run by themselves while you need minimal participation. A passive income continues to generate an income even when you are sleeping.

2. How They Are Created

Active income is generated from salaries, hourly wages, tips, and commissions. You have to continually put effort to generate an active income.

Passive income is generated from income-generating investments or assets like dividends, royalties, social security income, and rent. 

Read also: How to use debt to create wealth.

3. Time Taken to Set Up

For passive income, you do most of the work upfront. It takes time and years to set up a passive income source while the earnings may not be consistent.

For active income, you are paid based on the amount of work or hours you have worked. You have to work to earn an active income. Earnings are consistent and you can predict your income based on the number of hours and effort you have put in.

4. How They Are Taxed

Active income and passive income are taxed differently. Investors don’t need to pay social security or Medicare tax on passive income. Besides, investors can lower their tax liability on passive income through tax deductions.

Active income earners have to pay social security and Medicare tax up to a certain level depending on their tax bracket.

Read more: Financial freedom vs financial independence.

What is Better Passive or Active Income 

You could be wondering, between passive income and active income, which one is better. From an investor's point of view, having both is by far much better. It is good to have multiple sources of income. However, for real estate investors, passive income is better than active income.

Even if you have an active source of income, strive to generate a passive income through investments. Having a passive income is one of the best ways to prepare for retirement, or a bad day when you cannot work.

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This article was updated on August 9, 2022

Vincent Nyoike

Vincent Nyoike is an experienced business consultant and financial analyst. He is a CPA and is currently pursuing a Master of Science in Finance and Accounting at JKUAT. He holds a B.Sc. in Applied Statistics from the University of Eldoret