Passive Income vs. Active Income: Which is More Profitable?

Both active and passive income offer revenue streams to build long-term wealth. One is not inherently more profitable than the other, as you could have a passive income of $100 and an active income of $50,000, or vice versa. Building passive income over time can lead to a work-optional lifestyle or sustainable retirement. Read on to understand the differences between passive income versus active income and how both can help you build multiple income streams. 

What You Should Know About Passive Income

What is Passive Income?

Passive income is income that doesn’t require you to work actively. While active income trades your time for money, passive income generates money regardless of your actions. You can generate passive income from a product or system you’ve created, rental real estate, investments or any other income-producing asset.

Creators like musicians, producers and authors whose artistic creations earn royalties have passive income. Likewise, if you hire a property management company to manage your rental property, any income earned is completely passive. Finally, dividends from stocks or other investments, as well as appreciation of assets or capital gains, are all examples of passive income. 

In terms of lifestyle flexibility, passive income offers greater opportunities to choose how you spend your time. Passive income means you can make money while you sleep or play with your family on the beach. 

Pros and Cons of Passive Income

Passive income has advantages and disadvantages, although in most cases, the pros outweigh the cons. 

Pros:

• Earn income without working
• Flexibility to use your time as you want
• Save for retirement or a work-optional lifestyle faster
• Pursue other passions
• Doesn’t require active participation

Cons:

• Some types of passive income, such as investment income, come with risk of loss of capital 
• Unpredictable income amounts can make it challenging to budget if this is your primary source of income

Common Sources of Passive Income

While traditional passive income sources involve rental properties, royalties or investments, social media has opened new opportunities for passive income streams. Common passive income sources include interest and dividends from savings, certificates of deposit (CDs) or bonds, insurance income, affiliate income, rental income, peer-to-peer (P2P) lending and YouTube, TikTok, Instagram or blog ad revenue. 

Types of passive income:

• Rental income
• Royalties
• Capital gains
• Dividends
• Interest income
• Affiliate income
• Ad revenue from social media content 

Find more passive income ideas here.

What You Should Know About Active Income

What Is Active Income?

Active income is income you earn by trading your time and skills for money. As the name implies, you have to be actively involved to earn active income. This can include a salary from your employer, self-employment income or commissions on sales or real estate transactions. If you have a job or career, you’re earning active income. When someone mentions their career, the income earned from that career is considered active income. 

Doctors, lawyers, graphic designers, UX designers, accountants, nurses, teachers and most other professionals earn active income. 

Pros and Cons of Active Income

While active income has many advantages, it’s not without a few disadvantages that anyone who has ever earned it may have experienced. Here’s an overview of the pros and cons.

Pros:

• Sustainable income that you earn each week or month to support your basic living expenses.
• If you have a salary as an employee, active income is usually stable so you can plan on it each month. 
• Control and consistency in earnings.

Cons:

• Earning potential is limited by your available time or capacity to work.
• It can be time-consuming.
• In some cases, the earnings may vary, making budgeting more challenging.

Common Sources of Active Income

Common active income sources are professional income such as salary and wages, bonuses, commissions, consulting and freelancing. If you earn a salary or wages, that’s the most common type of active income. Bonuses or commissions for sales reps, real estate agents or other professionals. Business owners who are actively involved in their companies and take a salary or earn income also have active income. Finally, freelancing or consulting fees are other examples of active income. 

Common types of active income include:

• Salary
• Wages
• Commissions
• Bonuses
• Self-employment income
• Consulting fees

Passive Income vs. Active Income Tax Implications

Active income versus passive income doesn’t significantly change your tax obligations. Both passive income and active income are taxable, although in some cases, active income may be taxed at a higher rate than passive income. 

Passive income in the form of long-term capital gains and qualified dividends may receive more favorable tax treatment than ordinary income from salary or wages. In addition, certain types of active income, such as self-employment income, will be subject to additional self-employment taxes. 

Generating Both Passive and Active Income

It’s not a question of active vs passive income but rather how to optimize both to fit your lifestyle. Active and passive income are interconnected, and for most people, developing passive income streams while earning active income can be a strategy for long-term wealth building. There’s no reason you can’t take advantage of generating multiple sources of income actively and passively. By doing this, you diversify your income and generate greater overall financial stability as you’re less dependent on a single revenue stream. 

Building Passive Income vs Active Income 

Active income is the first type of income most people earn in their lives. It offers stability to create a budget, save for goals and plan for retirement. One of those goals could be building passive income streams. From music or book royalties to rental income or social media ad revenue, passive income streams can accelerate wealth-building for long-term opportunities. Ready to get started? Learn more about how to make passive income and three high-yield investments to boost income here. 

Frequently Asked Questions