The Difference Between Passive and Residual Income

The Difference Between Passive and Residual Income

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The thought of earning money without doing any active work sounds pretty nice. When people talk about “earning money while you sleep” (even though that’s a myth), they’re usually referring to passive or residual income. While the terms are often interchangeable, there are key differences between them. These are the key differences between passive income and residual income and how they can help you bring in extra cash.

What is passive income?

In theory, passive income is what it sounds like: Money you earn without performing the active labor of a typical day job. After you invest a certain amount of money or time upfront, this income will begin to flow with minimal effort over time.

Passive income can be as simple as renting a room via a home-sharing app or selling clothes online. Then again, most things that are considered passive income (real estate, book royalties, online sales, etc) take a lot more work and consistent effort than financial gurus would have you believe.

What is residual income?

According to Investopedia, there are three main definitions of what residual income means in different contexts (personal finance, corporate finance, or equity valuation). Personal finance is our primary concern. Residual income refers to any income that someone has left over after paying all their bills and debts. Your residual income can be used to determine your creditworthiness as borrower if you apply for a loan. It is essentially another term for discretionary income.

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This definition means that residual income is often passive; it does not mean that passive income is necessarily residual. You could use residual income from your main source income to fund a passive income venture. Both passive income and residual income are taxable, but not at the same rate as active income.

The bottom line

While both residual and passive income can boost your financial security, passive income is going to have a greater impact, as explained on Indeed.com. Think about it this way: Let’s say you pay all your bills and reduce your debt by $500 dollars one month, thus creating $500 in residual income. If you also rented out a vacation home that same month, you might have made over $1,000 in passive income–clearly a more significant gain. This is where the caveat lies. How you define passive income when it comes down to renting and maintaining a rental property.

Ultimately, when people are talking about extra cash flow with minimal effort, they’re referring to passive income over residual. To get your side hustles off the ground, you might need residual income. The passive income can help increase your total residual income.

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