What are the 7 Types of Income?

For most workers in the U.S., they are exposed to one, two or even three types of income in their lifetime. Did you know there are about seven governing types of income that anyone can have? There is no rule or law restricting how many types of income you can have, in fact many millionaires today will have about three to five income streams derived from this list! So what are the seven types of income and how can you be a part of it? Let’s go through this together:

  • Earned Income
  • Profit Income
  • Interest Income
  • Dividend Income
  • Real Estate Income
  • Royalty Income
  • Capital Gains

Earned Income

Earned income is the simplest form of income to participate in and many of us already know what this means. It means being a wage earner and getting a W2 at the end of the year.Most of us usually start with this income stream at an early age and when times are difficult and we need extra funds. Earned Income is a safe stream to be in because many companies are almost always hiring.However, it is important to realize that you are trading your personal time for money so there is only so much you can earn in your lifetime! Earned income is also the highest taxed income stream – up to 40% in some scenarios! There is nothing wrong with working a side hustle or small gig or even part-time or full-time work. Just remember, you won’t get ahead in life if you stick to just one income stream and if you do – come up with a plan to have multiple streams of income! Time is one of the many values of life we don’t ever get back so it is, indeed, very precious to each of us!

Profit Income

Profit Income is also known as Business Income. Say you’re working a small gig and you make enough money to turn it into a small business, congrats you now have profit income! It can be as simple as starting a part time Uber shift or selling products on eBay. The difference here is that you can scale it and make this job your own instead of solely working for another company.

Many business owners start an LLC because they wish to separate liability from their personal assets. Remember an LLC does not save you from tax liability, that is the power of the S-Corporation and also the final form of your small business! Each scenario will have its own benefits and restrictions so be sure to do your research or speak with an accountant for more information.

The significance of Profit Income is you can take MUCH more money then you’re able to from a W2 job. Even with a salary you can only earn up to that dollar amount regardless how hard you work. For business owners, however, you are entitled to the company’s profits (just don’t take too much!!) and can withdraw those funds at any time.

Consider your business structure! This is very important if you wish to stay in business long term (5+ years). A limited liability company will not have the same tax advantages as an S-corporation and a C-corporation will have many tax pitfalls if the business isn’t well suited for it. Understanding tax or having a tax professional in your business network is a smart and worthwhile investment if you wish to continue down the path of an entrepreneur. Never a bad idea to ask for help!

Interest Income

This is another example of an income stream where anybody can participate in! You can earn interest from a savings account, money market account, bank CDs also known as certificates of deposit and bonds from the U.S. treasury. When it comes to interest, the interest rate is where you want to look; is the interest rate fixed, variable or compounded?

A fixed rate will pay the same amount at the end of the period (monthly, quarterly, etc.) and is very easy to predict. Variable rates tend to change with the market and even in economic downturns so keeping a close eye will be a must. Compounded interest is the best kind where the longer you keep the asset the more it will grow in value even if you do contribute continuously. Many in the finance and investing communities consider compound interest the “8th Wonder of the World”!

Understand that interest income is a very low income producing stream even though it is mostly passive. Unless you are willing to hold hundreds of thousands of dollars at your local bank (which no one recommends) it is advisable to invest elsewhere.

Interest income is best used, in my opinion and experience, for your Emergency Fund. An Emergency Fund is also known as a “Rainy Day Fund” where life hits you hard and you’re stuck with a large bill suddenly. A simple example we’ve all faced is a car expense. Whether you have a flat tire or your engine shuts off – your life is now on hold and your now dreading what it’s going to cost just to get your car up and running again! We’ve all been there – repeatedly!

Having an Emergency Fund is great for these reasons so you can take care of these shortcomings and get back at it fast! When you don’t need those funds, keep them in a high-yield savings account or money market account so interest can keep growing it. Sure, if inflation hits there’s arguments that you would be “losing value” but that’s not the point! The point is having a small safety net to fall back on in case we lose our job or we get into an accident. We’re not going to use these funds for movies and popcorn!

Interest income is a safe, easy stream of income to be a part of but I’d recommend keeping the extra earnings in the savings account so that your Emergency Fund is growing without you having to worry about it!

Dividend Income

Many who are new to the investing world may have heard the glorious term “dividends” and get SUPER excited knowing that it is a possible way to retire early or even to supplement one’s income! While these dreams can, indeed, come true there are a few things to set straight. First, only invest in what you know! If you don’t know the whereabouts of the companies you’re buying into – stick with ETFs or mutual funds.

This is the cold, truth of investing. Sure companies can pay out dividends but these are also REAL companies with REAL employees with a board of directors and so on. If you aren’t following the financial whereabouts or interests of these companies on a regular basis (at least quarterly) then you might be shocked when one day they go bankrupt or they are bought out by another company you really don’t like!

When it comes to investing you will always hear this word “risk” and it comes in many different flavors. If you aren’t sure of what to invest in, again, stick to ETFs or Exchange Traded Funds. These are collections of stocks that are geared toward a certain goal or sector in the market such as energy, technology, being the top 100 or the overall top 500! A great example is the S&P 500 ETF. Averaging about 10% return annually, it tracks the overall 500 best companies in the U.S. There’s great diversity and exposure so if you’re looking for a “invest and forget” fund, this is a good starter.

If you wish to invest into individual companies for their dividends just understand they work. You receive payment for buying and holding stocks. These payments vary – some pay monthly, others pay quarterly. The more money you invest, the bigger the dividend. The risk involves the company’s activities and if they are making good choices. Coca Cola, for example, has been one of the best dividend payers for over 50 years! Clearly, they are making good choices! Another example of a possible risk if new companies offer higher dividend payouts to entice investors. Investors LOVE seeing a high ROI or return on investment so companies offering 10%+ sounds amazing but might actually be a red flag. If a company is paying out too much in dividends without leaving money to reinvest or grow then it is considered to be a red flag and risky asset to invest in. Always be aware of what you’re buying into and how the company is performing.

Rental Income

Rental Income is a great way to earning passive income fast! The downside is it has a large barrier to entry because you’re buying real property now. Consider the game Monopoly, the real object is to purchase real estate around the board and have the players pay rent until they can no longer do so! Such is the same or similar concept with real estate.

There are MANY tax benefits to real estate and many millionaires today are involved in real estate. Rental Income isn’t just about houses there are far more examples then that. Rental Income can be:

  • Multi-Family Homes
  • Single-Family Homes
  • Trailers/Mobile Homes
  • RVs & Campers
  • Apartments
  • Duplexes
  • Airbnbs
  • Renting out tools & equipment
  • Renting out vehicles
  • Renting out a room or storage space

This is just to name a few! If you have a storage place, garage or anything you can think of that you’re not using, consider renting it out! Renting and rental income, in general, have become far more lucrative in the recent years. Why? Well, people are always looking for deals and people are always in need of something so why not get paid?

If you own real estate, this can be a great way to invest without worry about the stock market. People will always need a place to live so finding tenants for your location won’t be a long term ordeal. Any profit you make will be considered passive income just be sure you account for as many expenses as possible!

Royalty Income

Royalty Income, simply put, is money earned for a product you are no longer working on. More commonly known as digital products, movies, music, songs, software.

For digital products, a common example, you would create something relevant like an ebook or ecourse, upload onto a platform and when you receive sales or commissions it would be considered to be residual or royalties. There are more specific regulations depending on the type of product you would create such as a song but the idea remains. Royalty income closely resembles profit income since you can make a good living if sales are consistent and can last forever!

A great example of successful royalty income is the Harry Potter franchise. What started as an idea turned into a book, then a movie, then merchandise, then theme park locations and experiences and more! Meanwhile for every purchase made at any point in this scale, its creator, J.K. Rowling is constantly earning royalties.

Anyone can make residual income constantly! All it takes is an idea and the drive to get it done. The same amount of energy you use to work and earn money is the same amount of energy you need to get started creating an a financial empire for yourself! Anyone can do it at any time so why not you?

 

Capital Gains

Capital Gains is the act of selling an asset. If that asset is a house or stock it still counts as a capital gain. If there is a loss at the time of sale, it will then be called a Capital Loss. Capital Losses can provide some tax relief but the main reason for purchasing assets is to make money not lose it.

That being said, capital gains are subject to capital gains tax which is anywhere between 0% – 20% tax. A very low rate based on your AGI, adjusted gross income, but still – tax is tax! When it comes to investing, tax is the silent killer of your ROI so if you’re thinking about selling assets, please think again!

Consider closely the reason why you would want to sell an asset. Are you moving to another state? Try renting out house! Are you losing money on this stock? Check the economy or the business financials to find out what’s going on right now. Most times a business may have made a bad move with one of its products but the board has plans to turn things around; check the industry to see if other competitors are facing similar issues. Might be wiser to hold on a bit longer than sell.

Many investors won’t dabble in this income stream because assets exist to make money for you. Selling assets wouldn’t make sense and for one very specific reason – cash flow! On a monthly basis, we need cash flow. This is the reason we work, we invest and we plan ahead. Without cash flow, we cannot make any choices in our lives so it would make sense to hold onto as many assets as possible and only sell if it simply doesn’t work out.