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Let’s face it.
Money is money.
Yet there is one type of money that brings a smile to my face more than any other: Money gained from Passive Income.
Passive income, as touched on in my Become A Capitalist Not A Laborer and The Capitalist Snowball posts, is a self-sufficient income stream that no longer requires human capital.
It is when you are no longer a slave to money and instead it becomes your servant.
Money can be a tireless worker that earns its keep even while you are asleep without ever taking a day off.
Through the 8th wonder of the world called compound interest, the principal can exponentially grow as the money it generates can then be employed to turbocharge the system further.
I recently told my colleague that although my passive income at its current state is approximately 7% of my active income, I get far more excited cultivating and monitoring that income stream than I do the latter one.
Why is that so?
I make far more money at work then I do passively, yet it is the dollars from my passive income stream that hold my interest the longest and brings the greatest joy.
In order to fully understand what’s going on I give you an example:
- Say you are walking along a street and find and pick up a $20 bill. No matter from what walk of life you are,I think that this would still bring an injection of joy into your life.
- This is literally found money. You might view it a bit of good luck. A gift.
- I don’t know about you but I certainly would tell people about it and probably grinning while I do so. I anticipate their responses would likely be of congratulations or how lucky I was.
- Now compare that feeling of found money to getting $20 you worked for on payday. Certainly doesn’t have the same feeling does it?
- I certainly wouldn’t be telling co-workers or friends, “Guess what I got?!? $20 from my payday!!” (and if I did, I’m sure they would not be impressed at all)
- This money feels ordinary, nothing special about it. In fact the IRS classifies this as Ordinary Income (quite an appropriate term)
And therein lies the beauty of passive income.
It creates the same feelings as those elicited in found money.
Some individuals even refer to it as “mailbox money,” implying that all you have to do is open up your mailbox and collect it (to be honest with direct deposits now readily available, even this term is obsolete with now even a greater level of implied passivity).
Money from your paycheck is associated with the labor you put in to get it.
Passive income breaks that association between human capital and true capital.
This result is the invigorating feeling and endorphin rush I get when I know I’m on the right side of the money equation (lender, not borrower).
Just this phenomena alone would make passive income a true winner, however there is yet even far more greater benefits to be had:
The IRS makes a major distinction between Ordinary Income (money earned from wages, short term capital gains and interest (some may question why interest is considered ordinary income as do I)) and Passive Income (income from long term capital gains or qualified stock dividends)
This simple distinction has major tax implications, highly favoring the passive income stream.
Ordinary income from all sources is taxed using the traditional income tax tables the IRS puts out, currently at 7 brackets with the top tax rate at 37%.
Passive income greatly benefits under tax law, with a maximum tax rate of 23.8% (20% maximum rate + 3.8% for the net income investment tax under the Affordable Care Act).
The difference in taxation of Ordinary/Active income from Passive income gives an interest arbitrage of 13.2% at the highest bracket, a considerable tax savings.
Currently I break down my passive income streams into two categories:
- Non-retirement Passive Income (80% of my passive income stream at the end of 2019):
- Income generated from dividends in my taxable/brokerage account and distributions from my shares in various LLC properties.
- Retirement Passive Income (20% of my passive income stream at the end of 2019):
- Dividends from my 401k, IRA (Roth and Traditional) and Health Savings Account
I make this distinction so that I can anticipate what kind of money I would have readily available if I choose to retire early (limiting my sources to the non-retirement passive income stream) and also what money I can expect when I do reach the age of traditional retirement (combining the above two sources).
I also have two more potential passive income streams that I keep track of but do not currently include in the above calculations:
- Expected Social Security benefits
- Pension benefit I received for my employment in the radiology residency program I trained at.
I consider this “bonus money” as this may or not be there when I reach the age of qualification, briefly addressed before in a previous post.
My ultimate goal is to continue to nurture/build these passive income streams so that they can support a desired retirement lifestyle and greatly minimize, if not completely eliminate, the need to withdraw principal.
If I can eliminate the need to access the principal of these investments, I would never be at the mercy of the market and it’s volatility (especially never having to sell assets during a market downturn and locking in losses).
Super-power Take Home Points:
- Passive income is perceived far more favorably by both the recipient and the IRS when compared to Active/Ordinary Income
- The ultimate goal is to create passive income from various sources that can provide sufficient income throughout retirement.
NOTE: The website XRAYVSN contains affiliate links and thus receives compensation whenever a purchase through these links is made (at no further cost to you). As an Amazon Associate I earn from qualifying purchases. Although these proceeds help keep this site going they do not have any bearing on the reviews of any products I endorse which are from my own honest experiences. Thank you- XRAYVSN
Spot on. I spend a lot more time thinking about how to maximize my side income streams than my main income stream. I could be bad at math, or it simply provides more joy for me. I like finding the random $100 checks that get mailed to me from my website.
I need to start growing other forms of passive income, but most of that is a long-game play for me. One of those pans is gonna catch in the fire. It’s just a matter of time!
Thanks for the comment TPP. You are definitely not bad at math. I think it is psychology thing where we are all programmed to appreciate passive income more because we feel like it is free money (and who doesn’t like free money?)
I’ve been spending TONS of time over the past year and a half building up my graphic design hustle. It’s not passive now, but the goal is to get to a point where I can just stop and the money will keep coming in for along long time.
Thanks Dave for stopping by. I think that is a wise decision to develop side hustles now that can more than make up for it later down the road with passive income streams. Much like becoming debt free has an emotional reward to it, passive income has a similar feeling. If you establish relatively strong passive income streams your mind is put at ease as you have an income floor that can hopefully provide for your basic needs in perpetuity.
This was so good. Many bloggers talk about how to get passive income and why it’s so awesome, but not many break down how it affects/implicates your taxes. Hopefully, this blog becomes a hefty source of passive income for you ?
Thanks MFM for the kind words. Yeah the IRS really doesn’t want us to be ORDINARY (lol). The tax arbitrage is quite impressive and makes each dollar from passive income much more valuable than each dollar from a W2 income. Thanks for the wishes on this blog, hopefully I can build it to something that can provide a nice side stream of income (but as you well know, blogging is not as passive as people think, it takes a lot of effort, but thankfully for me it has been a blast to do so)
Income streams are like my children – it’s so hard to pick a favorite.
I have to admit that I still have that $20 on the sidewalk feeling about my physician income. I live on a fraction of it and use the rest to generate passive income.
Like my children, I expect all these income streams to take care of me in my old age.
Thanks for stopping by SHS. That’s awesome you feel that way about your income (I have to admit too that I can’t believe what hits my checking account bi-monthly). But knowing that I work for it makes it less appealing than the money that I earn while I sleep. The fact that you are living on a fraction of your income is a great sign that pretty soon your passive income is going to rival the active.
Passive income is awesome when it truly is passive. We do not get the same tax breaks but we enjoy passive income nonetheless.
I plan to not need to access principal during retirement. Our passive income should more than cover our living expenses.
That is exactly the plan I am hoping for as well. If can live off of passive income streams and not touch capital you truly have won the game (probably won the game long before that if wanted to do the 4% rule instead).
Excellent post about passive income. One quick question though. Any revenue generated from blogging would be considered ordinary income too, right? I haven’t looked into this, so I’m not sure.
Also, is the “mail box” money that is received from RE syndication and crowdfunding treated as interest / ordinary income. Or is it taxed at the preferred capital gains rate?
Thanks in advance for the education 🙂
Unfortunately blogging falls into the ordinary/active income category. Money received from syndication does have some qualifiers to it that make it behave more like active income unfortunately. Interest payments for a crowdfunding debt offering are treated as ordinary income. The money gained from actual equity in real estate is a bit more interesting in terms of tax implications because early on most of the money you receive does not really have a corresponding tax increase due to depreciation offset. Of course if you sell the property you will have to eventually make up for this tax deferment unless you do… Read more »
Passive income is great and I’m trying to build that up through real estate. It does require up front education and work though. Blogging is not passive income. It’s like a second job.
I agree with you Millionaire Doc. I blame all the physician bloggers who came before me who made it seem easy. I had no idea what kind of effort it entails to put out a post (or even build a website). Definitely has to be a passion project for you to continue long term. I’m a little over a week out for my 6 month blogoversary and it honestly feels like I have gone through another residency in that time.
The tax advantages of passive income should have everyone finding a favorite tax accountant to help them.
Some may have investment advisors but not all also have a tax advisor.
Best thing we did was find someone who helped us through the tax side of our retirement plan.
Great point. In order to take advantage of these breaks you have to know exactly how to navigate through the tax code to get the best return possible.
I couldn’t agree more. I enjoy my job and the pay it provides me but find my passive income streams to occupy far more of my mind’s attention. I enjoy wearing my entrepreneur hat to devise strategies to grow that passive income from multiple streams. It’s constantly a challenge but one I’m willing, even happy, to accept. Aside from the money earned while doing other things, as you note, the latest tax reform legislation enhanced the attractiveness of passive income (particularly real estate) over active (ordinary) income. The ~13% differential becomes even more enticing and an incentive to find more… Read more »
Thanks Young and the Invested. We definitely have a similar mentality and to be honest you will be ahead of the game compared to me since you discovered this concept far earlier than I did. Sounds like some worthwhile information and definitely interested. My platform is more than open for you if you even decided you have enough material to do a guest post on.
Awesome post. There’s no income like passive income, that’s for sure. Smart to not include social security in your figures too. That’ll just be the cherry on top, and you’ll be able to delay that for a few years to get bigger checks.
Appreciate the comment TFT. Yeah I am pretty sure some semblance of social security will still be there when I actually claim it, but it is highly doubtful it will be at an equivalent level of benefits when compared to today. I will use that as bonus money as you said and hopefully never need to rely on it at all by that point.
Thanks for stopping by and commenting.
Passive income, the holy grail of FI. It really is fun watching the perpetual money machine do what it does and make more money! ? At least for now…. I think all of us newbs will have a harder time imagining all those little workers doing any good during the next bear. More like burning down the joint and running for it. Have to agree with everyone else, not much passive about blogging so far. And not many $100 bills making there way over here. TPP, want to sprinkle some this way! p.s. Nice fix for the comment color. The… Read more »
Appreciate the kind words Kpeds. The perpetual money machine is definitely something to strive for and I would say pretty much any physician regardless of specialty can construct (as doc G says all it takes is to front load the sacrifice). The best thing that I have noticed is that your savings rate bumps up dramatically in the end stages really turbocharging the system (right now 70%+ is my savings rate because my expenses are stable and the income from all sources is growing). Definitely resist the urge to burn it all down during a bear market and trust the… Read more »
Love this post! Such a great thorough explanation of passive income and what it is. I am still starting to discover passive income sources really for the first time in my life. I am in very beginning stages even when it comes to investing related to retirement. I love the way that you put this all so simply and I personally love that your passive income sources bring you Joy. Anything that brings you Joy in my opinion is the best income source.
Thanks Andrea. Well you are well ahead of the game as you have started this journey much earlier than I did. Time is the great equalizer. And yes it really does bring joy when something I envisioned a few years back has been put into practice and starting to pay off now. The best thing is I’m not done yet so love to see it continue to grow.
I love passive income too. The tax advantage is just one of the benefits.
You don’t get that satisfaction of a job well done, but the feeling is fleeting anyway. 🙂
I think I’m okay giving up the “job well done” aspect of it and give the credit to all my money that is now doing the work for me 🙂 I actually was able to reduce my workload by one day off directly because the passive income offset any loss I had for that luxury. I’m hoping slowly to keep reducing my workload while my capital starts doing the heavy lifting. 🙂
Thanks again for stopping by. Always appreciate it and the commenting.
I have to agree with you in saying “I make far more money at work then I do passively, yet it is the dollars from my passive income stream that hold my interest the longest and brings the greatest joy.” The smile on my face when I watch the dividends get deposited into the account every month. Man is it a feeling unlike any other. Getting paid to do nothing. Great article, I am looking forward to scouring the rest of your site.
Thank you so much for the kind words. Hopefully the rest of my site is up to snuff 🙂 (one of my favorites is another recent post: Uncle Sam worse than Bernie Madoff. And What’s The Alternative is a great snapshot of my current passive income streams if you are interested). Welcome to the site and hope you stick around 🙂 Appreciate it.
Totally agree with everything in this post, I think one of the things most people don’t realize is that building up passive income streams really does take a ton of time, but long term it can have such a great ROI and the most streams you can setup the better off you’ll be.
I was just explaining to doctors last night in a talk that although there isn’t such a thing as “bad income” some income is better than others. The active W-2 income that they actively work so hard for is the least desirable and the most common.
Passive income streams have the benefit of flowing whether you work or not (your money working for you) as well as a much lower tax rate. That concept was eye-opening for the physicians in the room.
P.S. My ancient eye muscles thank you for improving the contrast on the comment section.
Great minds think alike for sure 🙂 I’m glad you opened a lot of people’s eyes for passive income in that talk. It was eye-opening when I finally stumbled upon it myself. It’s almost like a hidden secret that only those in the know knew about it in the past. Well I hope the cat is out of the bag and more people can take advantage of it. I should be thanking you for giving me feedback on the comment entry color (when I saw exactly what you were talking about I thought that was an odd choice by the… Read more »
I just got an $18 deposit in my account from my monthly Redbubble t-shirt sales. And you’re absolutely right, that eighteen bucks is so much more thrilling than my regular check, even though $18 doesn’t go that far.
That’s awesome JoeHx. And I agree, the amount is not the basis for the psychological reward we feel, it is the fact that we have received money for something we actively didn’t have to work for (and hopefully it continues snowballing into more and more as it continues to build). Wishing you great success in your passive income endeavor and thanks for stopping by.
My wife and I have the same concerns about SS. We are not considering it at all in our plans, but it will be a nice bonus if we get any. I love looking at this income stream grow. I look at both how much I actually earned, and how much I could live on if I had to stop working. The latter is what helps me sleep at night on those days where work stress gets the better of me. It’s like aaargh I could just quit now, and live on this. Still, we have a plan and a… Read more »
Hey Genx FIRE thanks for the great comment. I personally think social security will be there but greatly reduced benefits (I hope you checked out my uncle Sam Worse than Bernie Madoff post last week and you will see why the program is in serious trouble). My passive income streams have allowed me to cut back on my main gig now (I take off a day each week which is essentially covered by passive income) and as that stream grows hopefully it will let me reduce clinical work days even more. My plan is around 5 yrs (and possibly 8… Read more »
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