Warren Buffet once said, “If you don’t find a way to make money while you sleep, you will work until you die.” And, the Oracle of Omaha isn’t exactly wrong.
The Bureau of Labor Statistics reported in 2019 that 8.3 million Americans worked multiple jobs. And, 49.4 percent of married-couple families included both spouses working. The reason? Well, according to a 2020 Sage study, this is “due to inflationary pressures in product markets including rising housing prices and child care costs coupled with relatively flat wage trends.”
What’s more, retirement plans have evolved from defined benefits to defined contribution plans. In turn, this leads to more dual-earner households being formed.
More concerning? The average American has $90,460 in debt.
In light of these facts, it’s safe to say that passive income should be on your radar. In addition to increasing your income, a passive income creates more freedom in your life. And, it can also ensure that you can enjoy your retirement.
Best of all? You can accomplish your financial goals without sacrificing too much of your limited time and money.
What is a passive income?
It may sound too good to be true. But, it is possible to earn money while you sleep. In fact, that’s the main goal of a passive income.
Suppose you receive an income from an activity that requires little to no management or participation on your part that’s considered a passive income. Rent, dividends, and capital gains from investments are some common examples of passive income. Commissions from affiliate marketing, royalties, and selling digital products are some other forms as well.
Generally, passive income advocates promote work-from-home and self-employed lifestyles. HOWEVER, the IRS defines passive income as either “net rental income” or “income from a business in which the taxpayer does not materially participate.” It can also include self-charged interest in some cases.
However, it’s important to refer to IRS Publication 925 when determining your allowable losses from passive income sources. This is because not all of these activities are considered passive activities.
Types of passive income.
Just like annuities, there are various types of passive income. This includes self-charged interest, rental properties, and businesses where the income recipient doesn’t directly participate. Rember, in order to be considered a passive income, it must play by specific IRS rules.
A partnership or an S corporation can receive passive income as long as the owner makes a loan to that entity to act as a pass-through entity. As a result, this can reduce double taxation. “Certain self-charged interest income or deductions may be treated as passive activity gross income or passive activity deductions if the loan proceeds are used in a passive activity,” the IRS states.
In most cases, renting out properties is considered passive income. One exemption is if you earn rental income from real estate. If so, this counts as active income. Unless you signed the lease before 1988 and have been grandfathered into the status of passive income, “self-renting,” in which you own a space and rent it to a corporation or partnership, will not qualify as passive income. The IRS notes, “It doesn’t matter whether or not the use is under a lease, a service contract, or some other arrangement.”
Furthermore, income derived from leasing land is not considered passive income. However, if a landowner’s property nets a loss during a tax year, they may be able to take advantage of the passive income loss rules.
“No material participation” in a business.
Let’s say that you invested $500,000 into a pet store. You and the owners agree that you’ll receive a percentage of earnings. In this scenario, this is a passive income. The caveat is that you can not participate in any business operations. If you do, that’s deemed material participation.
The IRS has standards for material participation, including the following:
- You’re dedicated over 500 hours to a business or activity that you’re profiting from.
- Your participation has been “substantially all” of the participation for that tax year.
- It has taken you up to 100 hours to participate in the activity, which is more than any other participant.
The benefits of a passive income.
Why bother with a passive income? Well, that depends on your financial situation and goals. However, a passive income can make you more financially secure and independent. And, it will certainly help you generate a higher quality of life in retirement.
Moreover, it can help you absorb economic shocks, like the 2007-2009 Great Recession or COVID-19 pandemic. And, it can also help you build a more diversified portfolio.
If you’re still convinced, here are eight more benefits of having a passive income.
Makes you financially stable.
The first milestone on your path to wealth? Financial stability. To put that more succinctly, if you know for a fact that you can weather any financial storm, then you’re in good financial health.
Better yet? If you get money without having to work your keister off for it, you’re one step closer to financial stability. And, when you are financially stable, you’re more confident in your decision-making. As a result, you won’t make poor financial decisions that could set you back.
Less reliance on a paycheck.
Make no mistake about it; living paycheck to paycheck is stressful. I can attest to this from personal experience. And, if also you happen to find yourself in that situation, a passive income can alleviate that burden.
Of course, this will take time and maybe even a little money upfront. However, once you’ve established a passive income, you don’t have to sweat pinching pennies anymore. And, you can finally live the life you want, whether if that’s starting your own business or living abroad.
Additionally, when you do not depend on a single income, you’re less stressed and anxious. For example, you don’t have to lose sleep over downsizing. Or, you have the peace of mind that you have enough to retire comfortably.
The value of time.
Unlike money, time can only be spent once. After that time has passed, it’s gone forever. As such, that makes time your most valuable resource.
What does that have to do with a passive income? In short, it gives you a chance to break away from the shackles and enjoy your life. While that doesn’t totally absolve you from life’s obligations, you’ll have more flexibility with your time.
Makes it possible to achieve your goals.
With a passive income, you’ll be able to reach your financial goals much more quickly.
More financial margin and consistency.
Creating a financial margin will maximize your financial returns in life. How so? Because you’ll be able to manage your finances better when you have wiggle room between your income and expenses.
With that in mind, creating financial margins is much easier when you’re earning passive income every month. For example, if your monthly expenses are $4,000 and a new income stream adds an additional $2,000, then life has just become a lot easier.
Moreover, a passive income can help improve your financial consistency. That just means you’re more consistent with saving and investing.
Many people believe retirement will only be achieved later in life. However, with a passive income, you might not be as far away from retirement as you initially thought. And, if you’re able to retire at a young age, then you have more time to enjoy the fruits of your labor.
Are annuities considered a passive income?
As a refresher, annuities are contracts that you purchase from an insurance or annuity company with either a lump-sum payment or installments. Eventually, your money will earn interest, and you’ll start receiving monthly payments. You should consider purchasing an annuity if you’re planning to live a long and healthy life.
It is important to carefully research all the different kinds of annuities available to you to see how they might work for you. In the right situation, annuities can provide an excellent source of incremental income without having to earn any additional labor. Here are a few of the best annuity rates you can find on the market.
When it comes to creating passive income in retirement, annuities are one of the most reliable and effective strategies. Mainly because there’s no need to participate actively once you have purchased your annuity contract. Just sit back and wait until the annuitization period begins.
Additionally, annuities generate higher income than other passive income streams like stocks, bonds, CDs, and mutual funds. And they provide a multitude of other benefits as well. These include tax-deferred arrangements, premium protection, and contract provisions that allow customization are available as well.
Other passive income ideas.
When you don’t have the time or dire to work an additional 25 hours every week, what can you do to bring in some extra money? Start with the knowledge and skills you possess. After that, explore passive income sources like;
- Index funds or dividend stocks
- Real estate
- Website or blog affiliate marketing
- High-yield savings accounts
- Investing in a business
- Credit card rewards
The bottom line.
While the return may not be as high as riskier investments, annuities are secure and one of your best options to supplement your other retirement income streams.