If you’re like most people, you dream of making more money. As an employee, your first instinct may be to learn new skills, negotiate a raise, or change employers so your earned income will be greater.
But, it’s important to realize that this isn’t the only option nor is it likely to be the best one. For many reasons, equity income pays better than earned!
Earned Income vs Equity Income
One common money myth is that every type of income is the same. For many people, it doesn’t matter how it’s made as long as they have enough money to spend on the things they need. But, once you dig a little deeper, you’ll realize that there are some key differences between earned and equity income.
Earned income is money that you make by going to a job, working for yourself, or through your small business. This type of income requires your active participation and if you don’t work, you won’t earn!
In contrast, equity income is money that you receive from assets you currently own or have recently sold. A few examples include dividends, capital gains, and cash flows from alternative assets, like real estate.
When it comes to making more money, most people focus on increasing their earned income. But, here are 5 reasons why you should concentrate on making more equity income, instead!
#1 – Tax Advantages
For starters, earned income and equity income get taxed differently. With earned income, you pay taxes according to the IRS’s marginal tax rates. As your income crosses from one threshold to the next, the percentage that you pay in taxes goes up as well.
As of Tax Year 2021, marginal tax rates range from 10 to 37%. On top of that, there’s also Social Security and Medicare taxes. If you work for a company, that’s another 7.65% of your pay. Besides that, most states have income taxes for you to pay as well!
As you can tell, making more earned income causes you to get taxed at the highest possible rates. But, when you make equity income, the IRS gives you tax breaks!
There are two types of equity income, short-term and long-term gain. A short-term gain is a profit that you make from selling an asset that you’ve owned for less than a year. While it does have the same marginal tax rates as earned income, you won’t pay Social Security or Medicare taxes which already gives you a 7.65% savings!
By owning an asset for a year or longer, you’ll pay long-term capital gains. Instead of paying a maximum of 37%, the highest tax bracket is 20%. But, if you have an extraordinary year, you may get subjected to the net investment income tax of 3.8%. Despite that, you’ll still pay significantly less in taxes!
To illustrate the point, consider three people who all make $100k per year, are married and file jointly. Person A has earned income, Person B has short-term gains, and Person C has long-term gains. Assuming they all tax the standard deduction of $25,100, then they’ll all get taxed on incomes of $74,900. Person A will pay $14,323, Person B $8,593, and Person C will pay $0. In every case, you’ll pay fewer taxes on equity income than you will on earned, and sometimes that bill will be zero!
Also, each year you make earned income you have to pay taxes. But, if you don’t realize a financial gain from your equity income, then you won’t owe any tax. Not only that, but by not selling, you’re allowing your equity income to compound to even larger amounts!
#2 – Time Freedom
Whether you realize it or not, your time on Earth is limited. Likewise, you don’t know how much you’re given nor how much you have left. Because of this, time is your most precious resource.
Having said that, it’s important to realize that earned income requires your time. You have to show up to work, exert energy, and perform. If you want to earn more, you’ll likely have to spend more time and greater energy to do it!
However, equity income can be made passively. Instead of using your precious time, it only requires you to save and invest your money!
Besides being less time-consuming, building equity income puts you on the path to financial freedom. Once free, you no longer have to trade time for your money, far from it. You’re able to pick and choose the way it’s spent, instead!
Truth be told, if you don’t find ways to use your earned income to make equity income, there’s a real possibility that you’ll work forever!
#3 – Unlimited Earnings Potential
The majority of people use their time to make money. But, they’re only 24 hours in a day. On top of that, you can only dedicate so much energy to work before you’ll crash. Due to these facts, there’s a limit on the amount of earned income you can make!
Also, it’s important to realize that most companies have salary caps. There is a maximum amount that they’re willing to pay based on a job’s role and function within their organization. No matter how wonderful you are or great of a job you do, there comes a point when it stops making financial sense for them to pay you more. When this happens, your earned income has hit the ceiling. You’ve maxed out and even though you want to make more, you can’t!
But, that’s not the case with equity income. It doesn’t have wage caps, corporate politics, or even golden handcuffs for that matter. With it, there’s no limit to the amount of money you can make!
Your equity income will get determined by the way you manage money during the accumulation phase. By living beyond your means, your equity income will be limited or nonexistent. But living below your means allows it to grow into significantly larger amounts!
#4 – Opportunities for Personal Growth
By now, it’s clear that relying on earned income makes you time-poor. While your job is one of the main reasons, it’s not the only one. You also have household responsibilities, relationships, and sleep. When they’ve all been said and done, you aren’t left with much time for personal growth or anything else for that matter!
By pursuing equity income, your personal growth comes to the forefront. Rather than taking the back seat, it’s a priority. Given that personal finance isn’t taught in school, it’s up to you to learn the money skills and financial strategies that will help you achieve your goals!
#5 – Financial Stability
When it comes to making money, most people are 100% reliant on their jobs for earned income. But without a job, they’d have no other source of income and likely be on the brink of financial hardship!
Unfortunately, many people haven’t realized that their jobs aren’t as safe and secure as they think. Even if they’ve been a loyal employee, there’s always the possibility that they’ll get downsized, laid off, or be without work due to factors outside of their control!
Those who have only earned income are also violating a basic financial principle. Instead of being diversified, they’ve put all of their income into one basket which also makes them vulnerable!
With equity income, you have greater financial security because you’re building independent wealth outside of your employer. Not only that, but you’re also creating an alternative source of income. This way, if something were to happen at work, you’d still have another one to rely on!
After reading this, it should now be obvious that there are many reasons why equity income pays better than earned. Not only are there monetary, personal, and lifestyle benefits, but it’s more likely to keep pace with inflation, too!
The next time you’re thinking about asking for a raise, stop and take a moment. Deep down, it’s not more earned income that you’re after. Most likely, it’s the time, money, and freedom that only equity income can provide!
How are you building up your equity income? Comment below.
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