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What are the different types of income?
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Different Types of Income
What do you mean by “types of income”?
How many different types of income are there?
To start with, let’s define what is income.
According to Investopedia, income is defined as follows:
Income is money or the equivalent value that an individual or business receives, usually in exchange for providing a good or service or through investing capital.
For instance, an individual may receive employment income by providing labor or a business can receive an income by selling products and services.
It’s important to understand the different types of income that you can earn so you can make the best possible financial decisions in your life.
Anyone looking to make money, build wealth, and live financially free should have a good understanding of the different types of income and how you can generate income streams to achieve your financial goals.
Very broadly, we can classify income in three categories:
- Active income
- Passive income
- Portfolio income
Let’s look at each of these three types of income.
Active income is a type of income that you generate by doing some work or participating in the generation of the income in a material way.
For example, when you render service and get paid, you are generating active income.
Active income is when you do something and get paid for doing it.
To make active income, you must either exchange your time and energy for money.
Here are some examples of active streams of income:
- Working a day job
- Consulting services
- Coaching services
- Working in a call center
- Acting as a sales person
- Building websites
- Doing graphic design
- Doing SEO consulting
- Acting as a real estate agent
- Working as a stock trader
On the other hand, passive income is when you do not necessarily participate in a material way in generating the income.
This does not mean that you do not need to work to generate passive income, it simply means that once you’ve set up the passive income source, you do not need to actively perform work to keep the income coming in.
For example, you can start a blog to earn a passive income or build an online store to make money passively.
You need to put in some of your time, energy, and perhaps some capital to start the blog or build your e-commerce website, but eventually it can start earning in you a steady stream of income.
You can earn passive income by investing in a business as a silent partner, invest in rental properties, or other assets where you do not actively participate in.
Here are some more examples of how you can earn passive income:
- Starting a blog
- Affiliate marketing
- Buying a website
- Renting property
- Renting equipment
- Publishing ebooks
- Selling digital products
Portfolio income is income you earn from investments, such as:
- Dividend income
- Interest income
- Capital gains
Generating portfolio income requires that you make money by using your money.
For example, you can generate dividend income by buying shares of stock in a company paying dividends.
You effectively use your money to invest in a dividend stock which in return generates you portfolio income.
Similarly, you can invest in peer-to-peer lending loans, purchase dividend-paying ETFs, or invest in books generating royalties.
Types of Income Streams
What are the different types of income streams?
There are different ways you can generate income, more specifically seven of them.
Here are the 7streams of income you should know about.
We’ll talk about their pros and cons, risks, and possible rewards.
Earned income is a type of income that you earn by working on a job.
For many, earned income is the only type of income they rely on to make a living.
Some may have good-paying jobs while others do not make enough to earn a decent living.
Generally, many workers feel safe on the job although your job is never guaranteed.
The advantage of earned income is that you have stability and predictability.
You can expect to put in 30, 40, or 50 hours a week and make a set amount of money.
On the other hand, you may not be financially free or earn enough to live the life you want.
You will need to adjust your lifestyle to reflect your earned income capacity.
Here are some examples of earned income:
Profit income is a type of income that you earn by selling your products and services.
This means that you either render service and get paid for the services rendered (which includes your profit) or sell products (above your cost for profit).
Those who earn profit income are entrepreneurs or self-employed individuals.
It’s definitely riskier to earn profit income than earned income but with more risk comes a higher possible reward.
If you are good at something (you have an expertise), or you are able to sell something you create or own, you can turn that into profitable income.
Here are some examples of profit income:
- Digital marketing advice
- Blog consultant
- SEO consultant
- Investment advisor
- Real estate advisor
- Graphic design
- Website building company
- Marketing advice
- Passive income advisor
Interest income is a type of income you earn when you put your money to work for you.
If you have extra cash, you can invest your money in investment instruments that allow you to earn interest income.
For example, you can put money in a regular savings account to earn a small amount of interest (something small is better than nothing), corporate bonds, treasury bills, or other types of government bonds.
Depending on the type of investment you make, you will assume a varying level of risk.
If you go into government bonds, you will take less risk than if you purchase corporate bonds.
Dividend income is an income type where, as a stockholder in a company, you receive the distribution of profits in the form of dividends.
Dividend income is one of my personal favorites among the 7 types of income listed in this section.
By strategically investing in dividend-paying stocks, you can generate passive income for many years to come.
When a company earns profits and has extra cash that it can distribute to its stockholders, it will declare and issue dividends.
Investing at the right time can not only provide you with a great source of passive income but you may also earn a profit on the appreciation of the stock value over time.
Rental income is a type of income that you earn by investing in properties or assets that you can rent.
Real estate assets are notorious for providing property owners with rental income.
For example, if you purchase a real estate property that you can rent to a tenant, you can generate rental income for the entire time you own the property.
This is truly an excellent way to build wealth over time.
Not all rental income opportunities are created equal.
Depending on your risk tolerance, you should focus on real estate assets or properties that closely match your expectations.
Capital Gain Income
Capital gain income is the profit you earn when you sell an asset over and above the price you initially paid for it.
You can earn capital gains by buying and selling stocks, bonds, or securities.
You can also earn capital gains by buying and selling real estate properties.
For example, if you buy a real estate property for $200,000 and sell it for $300,000, you will have generated $100,000 in capital gain income.
Depending on where you live or where the asset is being transacted, the local tax authorities may impose taxes on the profits that you earn.
To calculate your net profit (after taxes), it would be a good idea to speak to an accountant or a professional before buying or selling a property.
Royalty income is a type of income stream that you earn by licensing something that you built or produced.
You can generate royalty revenues by making music and licensing it, writing books and selling copies, building a software product, designing an image, making photos, you name it.
Authors, software developers, musicians, poets, inventors, and others who are able to build something unique and license them out can make a great amount of money in royalties.
Types of Income According To The IRS
According to the IRS, there are many types of income.
Here is a list of income types published by the IRS under Tax Topic No. 400 Types of Income:
- Wages and Salaries
- Interest Received
- Business Income
- Capital Gains and Losses
- Pensions and Annuities
- Lump-Sum Distributions
- Rollovers From Retirement Plans
- Rental Income and Expenses
- Renting Residential And Vacation Property
- Farming and Fishing Income
- Earnings for Clergy
- Unemployment Compensation
- Gambling Income and Losses
- Bartering Income
- Scholarships, Fellowship Grants, and Other Grants
- Social Security and Equivalent Railroad Retirement Benefits
- 401(k) Plans
- Passive Activities – Losses and Credits
- Stock Options
- Traders in Securities
- Receipt of Stock in a Demutualization
- Canceled Debt
- Acquisition or Abandonment of Secured Property
Type of Income Takeaways
So, what does type of income mean?
What is type of income exactly?
Some say there are two types of income, others say 4 types of income, or more.
In this article, I’ve broken down the different types of income in three broad categories and subcategories.
Broadly speaking, you have three types of income:
- Active type of income
- Passive type of income
- Portfolio type of income
If we include the subcategories to these three categories, you’ll have seven types of income streams:
- Earned income (active)
- Profit income (active)
- Interest income (portfolio or passive)
- Dividend income (portfolio or passive)
- Rental income (portfolio or passive)
- Capital gain income (portfolio)
- Royalty income (portfolio or passive)
Let’s look at a summary of our findings and what type of income means.
What Are The Different Types of Income
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