3 types of income explained
September 15, 2022 5 min read
Money doesn’t grow on trees. So where does it come from? You might be surprised to learn how many different types of income sources there are, especially in today’s gig economy.
Some sources of income—like your paycheck—may be obvious to you. But you may not have thought about other income streams. Understanding the big picture could help you manage your finances.
- Three of the main types of income are earned, passive and portfolio.
- Earned income includes wages, salary, tips and commissions.
- Passive or unearned income could come from rental properties, royalties and limited partnerships.
- Portfolio or investment income includes interest, dividends and capital gains on investments.
- Knowing about different income streams could help you plan for your future.
What is income?
Income is anything you gain that you can put in the plus or revenue column of your budget. It’s commonly measured in cash. Your paycheck may be the first source of income that comes to mind. But other types of income could include:
- Making tips and commissions on top of your regular wages or salary
- Selling goods or providing services at a profit
- Earning interest, dividends or capital gains on investments
- Winning prizes, awards and scholarship money
- Receiving gifts, allowances or inheritances
- Obtaining government benefits and tax refunds
- Withdrawing from retirement or pension funds
What are the different types of income?
There are different types of income, but three of the most common are earned income, passive income and portfolio income. The main difference is in how you make each type of money.
1. Earned income
Did you get paid to babysit, mow lawns or deliver newspapers as a kid? Even then, you were earning income.
Earned income is exactly what it sounds like: It’s money you earn by working—either for yourself, someone else or a business you own. It’s also called “active income” because you actively perform a service for it.
If you work for a company—from a small business to a large corporation—your employer may pay you an hourly wage based on the amount of time you work. Or your employer might pay you a salary, which is a fixed amount to do a certain job. Salaries can be paid weekly, biweekly or monthly, but it’s common for them to be expressed as annual figures.
Earned income could also include bonuses and extra pay. For example, taxi drivers and restaurant servers can earn tips. And people who work in sales can earn commissions.
Gigs can be another option for earning income. People who want to be independent, self-employed or work a part-time job may want to consider gig work. These side hustles are often temporary or short-term jobs performing a single task on demand. Musicians are a prime example. So are babysitters, freelance writers and food delivery drivers.
2. Passive income
Want to make money while you sleep? It’s possible to make money without actively working for it. That’s why it’s considered unearned or passive income. Rental income and income from royalties and limited partnerships are some examples of passive income.
Do you own anything other people may want to use? It’s common for people to rent or lease a second home or even a spare bedroom in their own house, which is considered rental income. Leasing a commercial building could also be a source of monthly income. Businesses can lease vehicles and equipment for a profit too.
Have you written a song or a book? Invented something? If you’ve designed, built or made something unique, you could get paid royalties for it. Royalties can be paid by someone who uses your work or other property for their own purposes. They may pay per item or by period of time.
If you loan a friend money to open a craft brewery in exchange for a share of their profits, for example, that could be considered a limited partnership. As long as you don’t actively work in the brewery, those earnings could be considered passive income.
Other examples of passive income include alimony, child support, unemployment, Social Security and worker’s compensation.
3. Portfolio income
A financial portfolio is a collection of your monetary assets. And portfolio or investment income can include interest, dividends and capital gains on investments.
Your bank or credit union may pay you interest to deposit your money into one of their accounts. For example, you can earn interest on checking accounts, savings accounts, money market accounts and certificates of deposit—commonly called CDs. The amount of money you make in interest can vary.
You could also earn money by investing in stocks, bonds and mutual funds. When you buy bonds, you’re essentially loaning money to a corporation or a government in exchange for them paying you interest on your money. When you buy stock in a company, you’re a part owner in that company, so you can share in its profits. Similarly, you can make money from mutual funds, which pool money from investors to make and manage investments.
Think of dividends as the payday on your investments. When a company makes money, it can pay a portion of its profits to shareholders. Corporations commonly pay dividends in cash. But you can also receive more stocks or other assets, such as property.
When you sell something for more than you paid for it, the difference is called your capital gain. With financial investments, you can earn capital gains when you sell a stock or cash out a pension fund whose value has increased since you bought it.
Different types of income in a nutshell
There are many different types of income you can earn. You can actively work for earned income, or you can let your money work for you in passive income streams. You might also earn income from interest, dividends and capital gains on investments.
The more you know about the different types of income sources, the better you can manage your finances—and maybe even earn more money.