Residual Income vs. Passive Income
The differences are subtle. Residual income may be passive income but passive income isn’t necessarily residual.
In personal finance, passive income may be derived from stock dividends or from renting a room on Airbnb. There was an initial outlay of money to buy the stocks or the house, but a tangential benefit that costs little in additional time or effort has been derived from the initial investment. It is residual income as well as passive income.
- Passive income is earned with little or no effort required after the initial investment.
- Residual income, for an individual, means the free cash available for spending after all obligations are met.
Is Residual Income Taxable?
Yes, almost all residual income is taxable. Maybe the income from some tax-exempt municipal bonds is not taxed. Otherwise, whether you got the tax from stock dividends or renting your spare bedroom, it’s taxable income.
Why Is Residual Income Important?
Residual income is often passive income. Passive income is, by definition, relatively effortless. Stock dividends and bond premiums are examples. To quote legendary investor Warren Buffet: “If you don’t find a way to make money while you sleep, you will work until you die.”
How Do I Calculate My Residual Income?
If you are applying for a loan, your residual income is the amount of money you have to spend after all of your monthly obligations have been paid. This is also called discretionary income.
If you are planning your long-term future, residual income takes on a different meaning. It is the amount of money you generate (or plan to generate in the future) from passive sources such as dividends and interest.
The Bottom Line
Residual income is not free money. It requires an upfront investment of money, hard work, or sweat equity. But once that work is completed, a stream of income has been established that takes little or no effort to maintain.