Passive Income
Definition
Income earned with minimal ongoing effort after initial setup — dividends, rental income, interest, royalties, and business income from systems that operate without daily involvement.
Passive income is money earned without active, ongoing work. Unlike a salary (which stops if you stop working), passive income continues flowing from assets, investments, or systems you've built. It's the foundation of financial independence — when passive income exceeds expenses, work becomes optional.
Common passive income sources ranked by accessibility: interest income (savings accounts, bonds — easiest to start), dividend income (dividend stocks, REITs — moderate capital required), rental income (real estate — significant capital and some management required), business income (online businesses, content, licensing — effort upfront, passive later), and royalties (books, music, patents — creative skills required).
The "passive" label is somewhat misleading. Most passive income requires significant upfront investment of time, money, or both, plus ongoing maintenance. Rental properties need tenant management and repairs. Dividend portfolios need monitoring and rebalancing. Online businesses need content updates and customer support. The income is less active than a job, but rarely truly passive.
The math of building passive income is straightforward but requires patience. A 4% dividend yield on a $500,000 portfolio generates $20,000/year. To build that $500,000 portfolio, investing $1,000/month at 8% returns takes about 20 years. Passive income is the reward for years of saving and investing — it's earned gradually, not created instantly.
Tax treatment varies by source: qualified dividends are taxed at favorable capital gains rates, rental income has depreciation benefits, interest is taxed as ordinary income, and business income may qualify for the QBI deduction. Understanding the tax implications of each passive income stream helps you optimize your overall tax burden.
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Frequently Asked Questions
What's the fastest way to build passive income?
Start with what you have: high-yield savings accounts earn interest immediately. Dividend ETFs start paying within a quarter of purchase. Then reinvest dividends to compound growth. There are no shortcuts — legitimate passive income requires capital accumulation over years. Beware of schemes promising fast passive income.
How much passive income do I need to retire?
Your annual expenses divided by your expected yield gives the required portfolio. At a 4% yield, $50,000/year in expenses requires $1.25 million. At 5% yield, it requires $1 million. Social Security and pensions reduce the amount your portfolio needs to generate. Build multiple passive income streams for security.