Are You Aware of the 4 Types of Income?
Pop quiz: real quick, what are the 4 different types of income?
If you attended the Vet Financial Summit, you know at least 2 types: active and passive.
Not quite sure?
Let’s go over the 4 types of income.
1. Earned income
Earned income is the most common way to make money. It’s what you earn in your job. You trade time and knowledge for dollars. This is active income, i.e. as the song goes, you work hard for the money. It includes salaries, wages, commissions and bonuses.
Also called W-2 income, earned income is taxed at the highest rate.
Self-employed income, aka 1099 income, is also earned income.
2. Ordinary income
Ordinary income is broken down into 2 types of income:
- Business income
- Non-business income, i.e. income from a pension plan or a 401(k) retirement plan
Ordinary income is also taxed at the highest rate (ordinary income rates).
3. Investment income
Investment income includes interest, dividends and capital gains, from stocks, bonds or mutual funds.
Investment income held for more than one year is taxed at the lowest tax bracket.
4. Passive income
Passive income only relates to business income (not investment income, not non-business income and not earned income).
Most of the work is done at the beginning. Once it’s set up, income is created without your time and your work. You can even “make money in your sleep” as the expression goes!
Passive income includes:
- Real estate (which is considered a business for tax purposes)
- A business in which you don’t work (car wash, pizza place)
- Online digital products (online courses, ebooks)
- Intellectual property (books, songs, royalties)
- Affiliate marketing (earn a commission by promoting other people’s products)
- Multi-level or network marketing (Amway, Tupperware…)
So which type of income is better?
There is no right answer to that excellent question.
They’re all good, in their own place and their own time.
You can’t draw income from a 401(k) when you graduate from vet school.
You can’t have passive income until you have a business that turns a profit.
You can’t have substantial investment income until you invest enough, and in the right vehicles.
In a perfect world, you would draw income from multiple sources.
When people talk about generating “multiple streams of income,” they usually refer to earning different types of income. For example, you can work at a practice (active income) and earn money in real estate (passive income) as well as dividends from stocks (investment income).
Creating the right balance is the Holy Grail. Part of our mission is to help you find your own balance as we take you on the path to financial freedom.
Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit