What is Passive Income?
The general description of passive income is income that comes from investments or from business interests. You don’t go to work each day to earn passive income, although managing your investments may still require work. Retirement, however you define it, is achieved when you don’t have to work to earn a living, but instead can count on reliable sources of passive income.
Learn How to Build Sources of Passive Income
Most people build up sources of passive income over time by working, then saving and investing some of what they earn. They build up their savings and investments to the point where the investments generate enough income that they can retire, and they then just manage their investments or businesses.
The book Rich Dad Poor Dad does a great job of helping you understand the difference between working for a living at a job verses working toward building a business and an investment portfolio that can generate ongoing passive income.
Once you have investments you have to learn to manage them so they generate reliable passive income. The article Withdrawal Rate Strategies describes a defined set of investment management rules you can follow to accomplish this goal by using a portfolio of index mutual funds.
Passive Income Mistakes
One of the mistakes people make when planning for passive retirement income is thinking they can put everything on autopilot. Managing investments, whether in the form of mutual funds, retirement accounts, businesses or real estate, takes time. You can hire good people to help you, but you still need to keep tabs on those people and on the work they are doing.
Cognitive abilities can decline rapidly after age 65 without you even being aware that it is occurring. For this reason it is important to have advisors and family members you trust. Share your passive income strategies with relevant people you trust and who you know will look out for you.
Before making any investment, check out 5 Rules to Avoid Making Bad Investments.
How to Get Passive Income in Retirement
- Passive Income from a Business
If you are looking for ways to build a business, start with evaluating your 5 E’s: Experience, Education, Expertise, Excitement and Explore. This process can help you find business ideas that leverage skills you already have.
- Passive Income from Investments
You’ll also want to learn as much as you can about how to invest for income. Check out 3 Types of Investment Income: Predictable, Variable or Guaranteed. It contains a list and links to many sources of passive retirement income such as interest income from bonds, dividend income from stocks, retirement income funds, and annuity income.
- Passive Income From Rental Real Estate
Many people create passive income through rental real estate. This can be an effective strategy, but you need to do your home work before heading down this path. Read 3 Things to Consider Before You Buy Rental Property to see how to evaluate rental real estate opportunities.
- Passive Income from a Network Marketing Business
Many network marketing businesses, also called multi-level marketing, tell you their business model is a great way to build passive income. I have seen people have a tremendous amount of success building these types of businesses, but I can tell you there was nothing passive about it. Like building any business, it required lots of hours and hard work.
Tax Definition of Passive Income
From a tax perspective, there is a more technical description of passive income.
The IRS defines passive income as “a passive activity is any rental activity OR any business in which the taxpayer does not materially participate.” Nonpassive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, or investment income.”
The definition above makes a distinction between passive income and portfolio/investment income. This distinction is used in determining what types of tax deductions might be used if you experience losses from a passive investment.
One of the key differences between passive income, investment income and earned income, is you don’t pay payroll taxes (FICA taxes such as Social Security taxes and Medicare) on passive income or investment income, although with recent changes to the tax code a payroll may be implemented in 2013 on all income over $250,000, including investment income.
Learn more about passive income in Introduction to Passive Income.