Achieving financial freedom may sometimes require more than just a regular paycheque from employment. While working for a living certainly pays the bills, sometimes, having a passive income on the side is what’s needed to take your lifestyle further.
Keep reading to learn the differences between passive and active income, as well as the reasons you should be making both at the same time.
Key Points
- Active income refers to earnings that you receive from performing work or services.
- Passive income refers to earnings generated with little to no ongoing effort.
- Examples of active income include salaries and wages, freelance work, and commissions.
- Examples of passive income include rental income, investments, and peer-to-peer lending.
Active Vs Passive Income: Snapshot
The following table breaks down the key differences between active vs passive income:
| Active Income | Passive Income | |
| Definition | Income earned through direct work or services | Income generated with minimal time and effort |
| Time & Effort Commitment | Continuous effort and time commitment | Initial setup effort with minimal ongoing time and work |
| Scalability | Limited based on number of hours worked | High potential with many passive streams available |
| Best For | -Covering current expenses -Establishing regular cash flow | -Long-term wealth-building -Achieving financial freedom |
What Is Active Income?
Active income is the opposite of passive income, meaning you’ll generally have to put in the time and effort to work to earn it. Whether you’re paid an hourly wage, sell for commission, freelance your services, or run a business, there’s generally a certain amount of work required to generate an income.
What Is Passive Income?
Passive income refers to any money you can generate with little or no effort involved. So, unlike your 9 to 5 job, where you have to put in a specific amount of work to make an income, you can invest time and/or money, and then wait for the potential returns.
Essentially, while passive income may not be as consistent or profitable as your regular salary or wage, it’s extra money you can make from the comfort of your own home at any hour of the day.
Learn more: Ways To Earn Passive Income In Canada
Types Of Active Income
Active income can come from multiple sources where you actively trade your time and effort for money. Here are a few examples:
Salary Or Hourly Wage
Most Canadians’ primary source of active income is their job. Whether you work for a company or work for yourself, you must put in a specific amount of time and effort in order to generate enough income to cover the cost of living.
Commission
In some industries, you may be able to earn extra money from commission fees by conducting various customer transactions. For instance, if you work in sales, you can make a percentage of how much you sell. This income type is highly variable, depending on your performance.
Tips And Bonuses
Similar to commission fees, tips, and bonuses are extra income that you can make after conducting some kind of sale or service. However, how much you earn is up to the customer or your boss.
Freelance And Contract Work
Many professionals are paid based on the work they produce. Examples of such freelancers are writers, designers, and consultants. The income earned fluctuates based on project availability and client demand.
Learn more: Pros and Cons Of Being A Gig Worker
Types Of Passive Income
Here are some of the most common examples of passive income avenues:
Investments Or Savings Accounts
When you make a return on an investment, it counts as passive income. While some investments are risky, the more money you add to your account, the more passive income you can collect.
That said, you can minimize your risk by investing in more conservative investment vehicles, like the following:
- Tax-Free Savings Accounts (TFSAs). Any income earned within a TFSA is not subject to taxes, allowing your investments to grow more quickly. Plus, you can withdraw funds from your TFSA any time without paying taxes on the withdrawals.
- Registered Retirement Savings Plans (RRSPs). Investments within an RRSP grow tax-free until they are taken out. This allows for potentially higher growth while the funds remain in the account.
Peer-To-Peer Lending
Peer-to-peer lending allows you to anonymously invest money in borrowers via an online platform, often in the form of loans or other financing products. So, when a borrower pays back their debt, you can collect a regular passive income from whatever interest the account generates. The higher the risk of default, the better the yield.
Rental Properties
Another way to earn income passively is to buy property and rent it out. Plus, you can take advantage of potential growth in property value over time. Just keep in mind that purchasing real estate requires a great deal of capital, and being a landlord can be time-consuming and stressful, particularly if you choose the wrong tenants or don’t pay for the services of a property management company.
Rental Spaces
A less expensive way to use real estate to generate a passive income is to rent out a room in your home. This way, there’s no need to purchase a separate investment property. You can rent out an entire floor, a room, or even your swimming pool if you have one.
Just be sure to get familiar with any potential tax implications of renting out a space in your home, whether short-term via Airbnb or long-term.
Dividends
Dividend stocks regularly disburse a portion of a company’s revenue to various investors. A blue chip business gradually increasing its payouts over time normally yields the best returns. So, if you invest in dividend stocks, you can make passive income and diversify your stock portfolio at the same time. If held in a TFSA, you can withdraw the income any time tax-free.
What Is The Passive Income Tax Rate In Canada?
The tax rate on passive income in Canada depends on the type and the source of income, such as rental income, investment income, or capital gains. Here’s a breakdown of how passive income is generally taxed:
Rental Income
Rental income is taxed as regular income and is added to your taxable income. That means your rental income is subject to the same tax rates as your employment income, which varies by province and income level.
Interest Income
Interest income from investments and various bank accounts, such as TFSAs, GICs, or stocks, is taxed as regular income. That means the income is added to your total taxable income and taxed at your marginal tax rate, which varies depending on your total income and the province you live in.
Capital Gains
If you sell an asset for a profit, then capital gains are realized. In Canada, only 50% of capital gains are taxable, and are then taxed at your marginal tax rate.
Learn more: How To Avoid Capital Gains Tax On Rental Property In Canada
Pros And Cons Of Active Income
There are many benefits and drawbacks to active income.
Pros
Here are a few of the pros of active income:
- Steady Payments – If your employment is salary or wage-based, you’ll generally see a faster reward for your efforts, since most regular jobs are paid out on a bi-weekly basis (while some contract work can be less frequent).
- Job Benefits – Many active-income jobs come with additional benefits, like vacation time, health insurance, and retirement contributions.
- Stable Lifestyle – If you hold down a good job with a reputable business, you should be able to earn a stable income for an extended period. Even contracting and freelancing can yield a decent active income if you find regular work.
- Potential Opportunities – Some jobs are competitive and allow you to move up in the business, which can help you secure a higher income and better employee benefits, such as dental insurance and other types of coverage.
- Sense Of Purpose – People often feel a sense of accomplishment when they are actively working to complete a task.
Cons
There are also some drawbacks of active income:
- More Time And Work Required – Active income requires ongoing time and effort, which can lead to stress and burnout.
- Not All Jobs Are Great – Unfortunately, some jobs are not enjoyable, and many employers may be difficult to work for.
- Job Insecurity – Employment can be uncertain, with the potential risks of layoffs or changes in job conditions. Running your own business can also be extremely risky and expensive, depending on the market and the specific type of company you’re operating.
- Opportunities Might Be Limited – Another unfortunate thing about some everyday jobs is that they may not offer the advantages you were hoping for. All salaries have a maximum cap and employee benefits may not be guaranteed.
Pros And Cons Of Passive Income
Passive income also comes with its own set of benefits and drawbacks.
Pros
Let’s look at a few perks of passive income:
- Less Effort Needed – You usually don’t have to work hard to earn a passive income and you can save a bit of stress on your body and mind. You choose the payment method, as well as how much time and money you want to invest.
- Residual Earnings – Passive income continues to generate revenue over time, even when you’re not actively working. This can provide you with a steady cash flow.
- Time Flexibility – Once set up, passive income requires minimal time commitment, giving you more free time to spend as you like.
- Scalability – Many passive income streams, like investments or royalties, have the potential to grow significantly without requiring additional work from you.
- Diversification – Multiple passive income sources can reduce your financial risk, which can provide some security if one income stream dwindles.
Cons
Some of the downsides of passive income are as follows:
- Commitment Is Necessary – You may have to invest a lot of time and money before you see a decent return. Even a simple stock portfolio can require plenty of upkeep, only for the payoff to be underwhelming years later.
- Risk Is Possible – Certain kinds of passive income, such as investments, can definitely be risky. Not only could you lose money when the market takes a dip, but it can also take years before you see a truly worthwhile return.
- Outsourcing May Not Be an Option – In many cases, you’ll have to monitor and disburse funds toward your own sources of passive income. After all, investment professionals and financial advisors can only do so much.
Final Thoughts
A bit of hard work, financial knowledge, and commitment can go a long way in building a decent passive income. Don’t forget, it’s all about the big picture. If making a passive income on top of your regular wage or salary helps you free up more time and money for future use, then the investment may be worth it.
