When I started my career, I was focussed on active income. Income that I had to work day after day for. A pay cheque or a salary so to speak. I only got paid if I put in the effort by going to work day after day. I was pulling in £27,000 a year from my day job. In order to attain this, I worked very hard. I often worked 45+ hours a week and was exhausted by the end of it. Having no time during the week, I did most of my chores and shopping on Saturdays and Sundays were a day to recharge in order to do it all again.
This is the way many of us earn our money and live.
While I was appreciative of the income, I also knew this was no way to truly live. I knew that I didn’t want to do this year after year. I didn’t want to be super exhausted during the week only to use my weekends to recover and recharge in order to go through the routine again. I truly wanted to live. There must be some other way.
This is when I found passive income .
For those that don’t already know, Passive Income is any income you don’t actually work for. It is income received on a regular basis that requires little effort from you to produce or maintain it. Examples include, dividends, interest, royalties, rent and licensing.
The great thing about passive income is that it doesn’t care how hard of a worker you are. The money flows to your bank account regardless of your effort. Now, you have to work hard – incredibly hard – to build up a passive income stream in the first place, but once that stream is flowing, it’ll likely continue to flow. Basically, you do the work once and potentially collect for the rest of your life.
This concept of active vs passive income changed my life.
I was able to realise that if I accrued enough passive income to cover my expenses, there would be no need for active income. There would be no need for me to go into the office day after day in order to clock the hours. I could simply sit at home or go the gym or hand out with friends and the money would roll in. The concept is similar to a person receiving pension payments, accept I wanted to be in this position in my 30s.
This is why I started investing in dividends. The idea of using dividends from big blue chip companies resonated with me.
Now dividends are not the only way to go. I chose it because it is what made the most sense to me. It suited me. You can just as easily collect passive income from rental properties or royalties. Further actionable examples of how to earn passive income can be found in my post titled ‘I made £1,500 in passive income last year – here is how I did it.’
Passive Income is taxed less.
One huge advantage of passive income is that it is taxed less.
You’d think that the government would punish you for making “easy” money like having to payer higher taxes. You’d think that there would be this major drawback to just sitting on your butt and collecting money.
But our economic system actually favours the investor class over the working class. As such, favourable taxation is just one more reason to prefer passive income over active income.
Let’s look at my personal situation as an example.
ISA accounts were created to entice people to save and invest more. Thus any income you receive in an ISA account is completely tax free! And on top of that, any capital gains you receive in an ISA are tax free!
This basically means I pay 0% on my dividend income!
Compare this 0% tax rate to that of your active income or salary. Not only do you have to pay 20% + in taxes on your salary, you also have to pay other dues such as N.I.
Even investing outside an ISA, dividends are taxed less. The first £2,000 you received in dividends is tax free. After that, basic rate payers pay 7.5%, higher rate payers pay 32.5% and additional rate payers pay 38.1%. This is way lower than normal active income where rates are 20%, 40% and 45%!
A Dollar Of Passive Income Is Worth More.
Or should I say a pound of passive income is worth more.
There are a number of reasons I say this.
- Less Effort Required – Once the passive income starts to roll in, no effort is required in your part for money to hit your account. Compare this to active income where you need to show up every day.
- No associated costs – No lunches with co-workers, no uniforms, no dry cleaning, and no transportation costs to and from work.
- Lower Taxes – Investing in the right vehicles will ensure you pay lower or no taxes for the passive income you obtain.
- Not tied to a location – As you are paid to just sit around, passive income does not require you to live in a certain location.
Compare this with active income where you need to live within a certain radius of your job.
This is why I say passive income is better.
As further food for thought, have a think about this.
Think of it this way. If someone offered you a job which paid £30,000 per year in exchange for about 2,250 hours of your life annually or they promised you £24,000 in passive income that would increase at least in line with inflation for the rest of your life, which would you choose?
I’m sure most of you would choose the passive income. The amounts are the same once you factor in various taxes so why would you not choose to be more free, more flexible and have lower expenses ?!