Why You Need Both Passive and Active Income

Written by Bryan Daly
Fact-checked by Caitlin Wood

Why You Need Both Passive and Active Income

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Income Investing Saving

As you get older and take on more expenses, eventually you may need to start earning a higher income. Not to mention, making a steady income is one of the best ways to get approved for important financial products and services, like an affordable mortgage or car loan. Thankfully, there’s more than one way to rake in a respectable income. 

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.

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, 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.       

What is Active Income?

Active income is almost the opposite of passive income, meaning you’ll generally have to work harder and put in more hours to earn it like you would at your day job. That said, you can make an active income whenever you trade your time for payment. More often than not, people put forth the effort in their earlier years, then gradually try to make passive income so that they can live easier later in life, then hopefully retire comfortably.           

Types of Passive and Active Income

In Canada, you can earn many types of passive and active income, each with its own set of benefits and drawbacks. Here are some of the most common examples: 

Passive Income

• Investments or Savings Accounts – When you make a return on your Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP) or other 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.

• Peer-to-Peer Lending – This service 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. 

• Rental Properties – Another expensive but simple way to earn income passively is to buy property and rent it out. While long term rentals can sometimes yield better results than short term rentals, you’ll have to deal with the all upkeep, financing and tax bills of what could be multiple properties.

• Dividends – Dividend stocks regularly disburse a portion of a company’s revenue to various investors. A 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.   

Active Income

• Salary or Hourly Wage – Of course, most people’s primary source of active income is their job. Whether you work for a company, small business or your 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. Your employer may also pay you in cash, based on your overall sales productivity. 

• Tips – Similar to commission fees, tips 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, as tipping isn’t usually obligatory. While a 15% tip is a standard request in many industries, even hard workers might not earn what they deserve.    

• Side Hustles – Earning money with side hustles, like private tutoring, freelance work or other odd jobs outside of your regular salary/wage can also qualify as active income. Even if you don’t earn a steady stream of money from the side hustle, every dollar counts, especially if you market your skills well.

Pros and Cons of Passive and Active Income

There are many benefits and drawbacks to all forms of passive and active income, including but not limited to:

Pros 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.

• The More Time & Money You Invest, the More You Can Earn – If you’re patient and prepared to handle any problems that come your way, the eventual rewards can be worthwhile, even if you have to wait years for your investment to pay off. 

• Live More Comfortably – As mentioned, many people like making passive income because it can slowly reduce their workload. Not only can it help you retire earlier, but you can also use it to free up more time and live the way you want.

• Diversity & Growth – Some forms of passive income can have a compounding effect, allowing you to earn more and more money over time (maybe even an unlimited amount). Plus, diversifying your financial profile is never a bad thing.   

Cons of Passive Income

• 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 – Most of the time, 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.     

Pros of Active Income

• More Frequent 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). 

• A Steady Living – 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. 

• Less Financial Stress – If you use your active income responsibly, you should be able to deal with your everyday expenses with little to no stress. Plus, you can save for any large future costs, such as mortgage payments or a family vacation.

Cons of Active Income

• More Time & Work Required – Working full-time for years on end can be very tough on your body and leave you with less time for personal matters, especially if you’re working in an entry-level position or starting your own business. 

• Not All Jobs Are Great – Unfortunately, it can be tricky to find an employer that treats you well and pays you what you’re worth. Running your own company can also be extremely risky, expensive, and time-consuming until the business takes off. 

• The Opportunities Might Be Limited – Another unfortunate thing about some everyday jobs is that they may not offer up the advantages you were hoping for. All salaries have a maximum cap and employee benefits may not be guaranteed.

Additional Reading

How to Invest in Real Estate?

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Pay Down Debt or Invest in RRSPs?

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How Much of My Income Should I Save?

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Why Do You Need Both Passive and Active Income?

In Canada, the average cost of living can be substantial and once you’re past a certain age, it can be tough to get by without having at least one reliable source of income. In fact, the more types of income you can earn, the easier it will theoretically be to get your biggest expenses out of the way, save up money and take time for yourself.

Although you can accomplish all this if you manage to find a decent job, the simple truth is that you may end up living paycheck-to-paycheck for a long time. That’s why it’s a good idea to start making passive income on the side. Even a basic RRSP, TFSA or stock portfolio can accumulate a lot of interest over time and help you buy a home, finance the vehicle you’ve been eyeing or reduce your workload later in life. 

Passive & Active Income – FAQs

Is passive income taxable in Canada?

Yes, just like active income, most types of passive income are subject to taxation in Canada. Different tax rates and brackets exist for different sources of passive income. 

For instance, by making more passive income, you may fit into a higher tax bracket and have to pay more during tax season. The same rule applies if you’re married and filing joint passive income taxes (the higher your household income, the more you’re taxed).

How much money can you make with a passive income?

The amount of passive income you actually make depends on which method(s) you’re using to earn it, as well as how much time and money you’re willing to invest. Remember, while passive income can be easier to earn than active income, it may require some skill, patience and commitment before you see any favourable results.

If you’re financially prepared and willing to accept some risk, you can invest more and potentially receive a bigger payout several months or years later. However, if you want to take as little risk as possible, there are still plenty of safer investments and financial accounts that you can use to collect a decent amount of passive income.

Are capital gains considered passive or active income?

If you make a profit by selling stocks or real estate properties (capital assets), it qualifies as a capital gain, which is considered a form of passive income. The same principle applies to your personal assets, like your vehicle or home. The amount you eventually pay in taxes depends on how long these kinds of investments are held for. 

For example, if you make any capital gains from a short-term investment (one year or less), they may be taxed at a similar rate as your regular income. If you invest long-term (for more than one year), your gains might be subject to a lower tax rate. 

Interested in Earning Some Passive and Active Income?

If that’s your goal, a bit of hard work, financial knowledge and commitment can go a long way. 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 has definitely been worth it.