Passive Income vs. Active Income: Understanding the Key Differences for Financial Freedom

An illustrated image showing the concept of passive income versus active income, with a person comfortably seated on a couch, juggling coins marked with dollar signs, alongside bees symbolizing income flow, against a Honeygain logo background.
Dec 5, 2023 last_updated min_read

Do you get anxious just by thinking about income streams, dividend stocks, investing capital, and, namely, passive vs. active incomes? Understanding the key differences between the different types of income is important if you want to improve your personal finance and start making money.

Active income is the money you make when you work for it and regularly put in time and effort. Passive income is the money you earn without your active participation. 

This blog post will go into detail about the difference between passive income vs. active income, the types of passive income and active income, and the pros and cons of these income streams. It’ll help you decide which is a better income stream for you.

Keep reading if you want to generate income quickly and build personal wealth!

What Is Income?

Let’s start with the basics. Income is the money you get for your work over a particular period. Companies also get income from sales or services they offer over time.

The average income globally is $12,235 per year. The residents of Monaco earn the highest income, at around $186,000 each year. And citizens of Burundi earn the lowest pay in the world. Their average annual income of only $220 per year.

passive vs active income

What is Active Income?

When you hear the word ''income'', you probably think about active income. Just like we mentioned before, active income is the money you earn with direct involvement. You must be actively involved to create active income, i.e., physically working for your money.

Types of Active Income

Many ways of earning active income include salaries and wages, self-employment, and extra money from commissions and bonuses.

  • Salaries and Hourly Wages: The most common form of active income sources are salaries, and an hourly wage, which are regular payments you receive for your 9-5 job. Simply put, you generate active income in exchange for your time.

    The average annual active income salary in the USA is $76,370. The average hourly wage of a USA worker is $29.81.

  • Self-Employment: Another way to generate active income is to start your own business and become your own boss as a freelancer.

    Revenue generated through working for yourself comes in many forms, including an online business, consulting fees from a consulting business, etc. The average USA citizen who owns a business makes around $84,305 annually.

  • Commissions and Bonuses: The money you earn depends on achievements, such as hitting a sales goal or completing a project. The active income generated through commissions and bonuses heavily depends on your success.

    Most commonly, you’d earn a bonus at the end of each year. This bonus will vary based on your industry, but the average bonus in the USA is 11% of an employee's salary.

  • Short-Term Work: Another option for earning active income is through short-term work, known as gig work. These temporary roles involve performing specific tasks on demand.

    Musicians, babysitters, freelance writers, and food delivery drivers are all examples of gig workers.

Advantages of Active Income

Many believe that active income is the best choice if you're looking for financial stability. That's because your salary arrives at your bank account regularly, once a week, once every two weeks, or on the same day every month.

You can always trust that you'll receive the same sum of money regularly, so you can sleep easy knowing you have a consistent income.

Active income has almost no risks involved because you have a contract with your employer, and they have to act according to that contract, meaning that your local work laws protect you.

Disadvantages of Active Income

The main drawback of active income is that the amount of money you can earn is limited – if you work a full-time job, you probably won't have enough time for a different job to increase your earnings.

One of the disadvantages of active income is that it's usually followed by a significant tax liability — the tax rate for wage earners goes anywhere from 10% to 37%, depending on your annual salary. 

Many are unhappy with this tax liability because you don't get to enjoy a large portion of your active income.

Your salary depends on your boss, and you can try to convince them to give you a raise, but that won't always work in your favor.

passive vs active income

What is Passive Income?

It's time to move onto passive income — the money most people think about when they dream about financial freedom. Passive income opportunities allow you to earn money while you sleep. Passive income consists of cash acquired through an initial investment that doesn't require further effort.

Ways of Earning Passive Income

There are many ways to build passive income. You can generate passive income if you own rental property in good real estate markets, invest in something, own an income-producing asset, or do a variety of other things to kick off generating passive income.

Here are just some of the examples of passive income sources.

  • Capital Gains: A capital gain is the money you earn after you sell your capital assets, which include things like valuable art, a house, a car, and stocks are considered capital.

    Capital gains belong to one of two groups: short-term and long-term. If you own an asset for a year or less, those are short-term capital gains. But if you owned something longer, that’s considered long-term capital gains.

    Let’s look at an example: Dorothy bought a house for $100,000. She had her house renovated and later sold it for $200,000. The $100,000 difference that Dorothy received is her capital gain passive income.

    Capital gain, are an excellent way to create passive income because they receive a favorable tax treatment, meaning you’ll pay less taxes on your income.

  • Portfolio Income: You can earn portfolio interest income through investments rather than regular employment. You can earn passive income from sources like stock dividends or bonds.

    Active portfolio income requires more involvement from the investor, such as actively managing a stock portfolio or participating in real estate investments.

    On the other hand, passive portfolio income comes from investments requiring less involvement, such as rental properties or stock dividends.

  • Rental Income: If you have enough savings, buying a rental property and renting it out for passive income may be a great idea. Each rental property will generate passive income for years to come with minimal effort from you.

    Buying real estate isn't accessible to everyone, but if you're lucky enough to afford it, you can let real estate agents handle the day-to-day operations while you sit back and enjoy your passive income stream.

  • Interest Income: If you lend your money to someone or choose to invest it into something, the money you make is considered interest. The interest you'll earn depends on how much money you want to invest and the interest rate the lender offers you.

    It’s not hard to start earning interest. Begin by opening a savings account or depositing money into a financial institution that offers interest. After some time, interest will build up increasing your wealth.

    Earning money through interest can sound daunting, but with the help of a good strategy and a trusted financial company, you can start making money quickly.

Suppose none of the above-mentioned examples of passive income sources sound good. In that case, we recommend you look into selling online courses or using money-earning apps (more on those later!).

Advantages of Passive Income

Generating passive income comes with clear advantages — freedom and flexibility. If you can comfortably live off of passive income, you never have to work a regular 40-hour work week again! You won't need to work for your money actively, and you can enjoy your life worry-free.

Another advantage of passive income is that some are suitable for potential tax deductions, which means you'll get to keep more of the money you've made.

Disadvantages of Passive Income

All passive income streams have some drawbacks, just like everything else. The main disadvantage of earning passive income is that you probably won’t make enough money to live comfortably. 

Most ways to earn good passive income take time to add up. You should wait before quitting your regular job to live off your passively earned income.

Passive income is also pretty unreliable. You won't know how much money you'll make every month or year, which can stop you from planning for financial goals or reaching the financial freedom everyone dreams about.

Challenges and Risks of Passive Income

It's important to mention that starting a passive income source comes with many challenges and risks. Especially if you don't have prior knowledge and experience.

Any passive income stream requires at least a little of your resources, whether money or time. And there's no guarantee that it'll be worth it. We all want to become rich quickly, but nothing’s guaranteed. Only invest the time and money you can afford to waste.

Another risk of earning cash passively is that you can never know when the faucet will shut off because consistency isn't guaranteed with passive earnings.

passive vs active income

Passive Income or Active Income — Which is Better?

Now's the time to choose between active and passive income. Or would you prefer to combine both active and passive income sources?

Impact on Lifestyle

Passive and active income sources have a contrasting effect on your life. If you choose to earn active income, you'll have to get a full-time job, and your schedule won't be up to you. Most people who earn active income work every Monday through Friday and only get to relax during the weekends.

If you earn passive income, you don’t have to work according to a schedule. This means you get to enjoy your life to the fullest. But you'll also need to motivate yourself to put effort into your income streams occasionally.

Financial Implications

Passive and active income are both great ways to build wealth. However, passive income doesn’t require you to sell your time for money consistently. You can invest in something once, which will take you 30 minutes tops, and enjoy the same amount of money you could make in a week. 

Passive income may take longer to collect in your bank account. But the money will grow each time you find a successful niche. Passive income will also bring you more tax benefits than active income.

How to Transition from Active to Passive Income

The most straightforward way to turn active income into passive revenue is by launching a business. Let’s look at an example of affiliate marketing, which involves posting pictures of products to social media with a unique link. 

If someone but that product using your unique link, you get paid. But to make affiliate marketing profitable, you’d have to look for new products to market regularly, keep up with social media platforms and consistently upload new content. 

While the research on which products to market will take some time, you could automate the day-to-day operations of posting content with tools that allow you to mass-schedule posts for the future. This way, you’re saving time but still making money from the products you post.

The key in this transition is to find something you’re interested in, find ways to cut corners and automate, and then watch the money flow!

Active or Passive Income

You’re now caught up on the intricacies of passive income vs. active income! Active income is the monetary equivalent of your labor over a specific period. You're probably one of many salaried employees at a company, and that company pays you.

And for final thoughts, passive income is the money that grows in your wallet without your physical presence. People earn passive income in many ways, from owning rental properties to investing in the stock market.

Pick one type of income or mix and match active and passive revenue to boost your savings – no matter which type of income you decide to pursue, we hope you succeed in earning money and reaching financial security. 

And while you reach your financial goals, we invite you to try out Honeygain – an innovative app that’ll pay you for sharing your unused internet connection.

With Honeygain, each user shares their internet connection and gets paid in return. Why do they get paid? Because their unused internet is used by researchers and scientists to conduct data-driven projects, like ad verification, brand protection and more!