Passive Income for Retirement
Passive income is money you derive from sources other than paid labor. Common examples include owning rental property and participating in a limited partnership. Once established, passive income streams in retirement require little time and effort to maintain.
What Is Passive Income?
Passive income – also known as residual income – can mean many things to different people. Generally, it is a way to earn money with minimal daily effort and is not attached to an hourly wage or annual salary.
Many people consider passive income during retirement planning because it helps supplement other income, such as Social Security and pensions.
Having multiple sources of income, including those that require minimal effort over time, can provide financial freedom and security as you grow older.
Passive income does require some work in the beginning. A substantial upfront financial investment is usually required as well.
Like planting a seed or growing a garden, passive income often means reaping the rewards of your previous efforts and hard work.
How To Make Passive Income During Retirement
Passive income comes in many forms such as real estate, businesses, dividends and annuities.
Before you get started, it’s important to identify your current financial situation and goals. How much money can you afford to invest, and what are your expected average returns? Sometimes the safest and easiest passive income streams don’t generate much money.
- How much money do you want to earn and for how long?
- How much time and effort is typically required to generate your desired income?
- Is an initial upfront investment required?
- What is your risk tolerance?
- Do other people make money doing this?
- Does this idea show a positive long-term track record?
Keeping track of multiple sources of income can be challenging. Pay attention to how much money you spend to maintain your passive income stream.
For example, consider the property upkeep costs and repairs needed to maintain a rental property.
It’s also important to note that the IRS has a more specific definition of passive income.
- Trade or business activities in which you don’t materially participate during the year.
- Rental activities — unless you’re a real estate professional.
While financial experts may consider certain types of investment income passive, the IRS considers it to be portfolio income subject to capital gains tax.
If you’re exploring passive income streams in retirement, speak with a financial planner or accountant to learn more about tax treatment.
Types of Passive Income That Works for Retirees
After assessing your financial situation and goals, you can explore different types of passive income that work for you.
Below is a brief list of options. You may discover others by conducting your own research.
- Rental Income
- Renting out a second property is a popular retirement investment strategy. Keep in mind that being a landlord can be challenging and time-consuming. Experts recommend buying property somewhere nearby that’s convenient for you to visit and check on.
Hiring a property management company is another option.
- An annuity is a contract between you and an insurance company. These financial products offer a guaranteed income stream and are primarily used by retirees. You can purchase an annuity with either a lump sum of cash or a series of payments.
Annuities can be highly customized to meet your specific income needs. Make sure you read and understand your annuity contract before signing.
- Dividend Income
- Dividend stocks distribute part of the company’s earnings to shareholders quarterly. Some companies increase their dividend payout over time. Dividend stocks are generally less volatile than growth stocks. You can also choose to reinvest dividends to increase long-term cash flow.
- Interest Income
- Interest from high-yield savings accounts and certificates of deposit (CDs) generate interest you can use as supplemental income in retirement.
High-yield accounts earn a higher interest rate than the average savings account — roughly 0.4 annual percentage yield compared to 0.06 APY for typical savings accounts. The average CD yield varies by bank and term, with 5-year CDs offering higher rates than 1-year CDs.
- Royalty Income
- Royalty income is generated when you own the rights to an asset, such as a piece of art, music or literature. You can also earn royalty income from the extraction of oil, gas or minerals that is licensed for other people to use.
- Renting Out a Room or Vehicle
- If you’re not ready to invest in a second property, you can still earn passive income by renting out a spare room in your home. Having a roommate or an occasional Airbnb guest is one way to add extra money to your budget — if you don’t mind sharing your home with others.
Another option is renting out an RV or trailer, if you own one, by using websites like Outdoorsy or RVShare.
Passive Income Benefits and Risks
Passive income can be a great way to supplement your retirement — but it’s important to consider the downsides, too.
For example, revenue from different types of passive income — such as rental income, investment income and royalties — receives different tax treatment from the IRS.
You need to keep good records, and you’ll probably want a tax expert to help you navigate the process.
- More free time
- Location flexibility
- Financial independence and security
- Potential tax consequences
- Time and effort required
- Financial investment
- Returns may be different than what you anticipated
Make sure to consider both the pros and cons of potential passive income streams before getting started.
3 Cited Research Articles
- Internal Revenue Service. (2021, March 11). Publication 925: Passive Activity and At-Risk Rules. Retrieved from https://www.irs.gov/pub/irs-pdf/p925.pdf
- Francis, S. (2019, January 4). What to know before building a passive income stream. Retrieved from https://www.marketwatch.com/story/what-to-know-before-building-a-passive-income-stream-2019-01-04
- U.S. Securities and Exchange Commission. (n.d.). What are annuities? Retrieved from https://www.investor.gov/introduction-investing/investing-basics/investment-products/insurance-products/annuities