Cash-Ins: Active vs. Passive Income

For most new graduates, the primary source of cash is through receiving a paycheck as an employee. An hourly employee sees cash in proportional to hours worked. A salaried employee receives a routine cash payment on a set time interval (weekly, biweekly, monthly). While an hourly employee may see slight variation, there is still some income predictability based on schedule and minimum number of hours unless you are considered part time or a casual employee.

Cash MoneyEarning a paycheck for services performed, such as working a shift at the pharmacy, is considered active (or earned) income.[1] The way in which you make money is also important to the Internal Revenue Service (IRS).   The IRS defines “earned income” as all the taxable wages you get from working.[2] In contrast to active income, passive income is earned regardless of time or direct contribution. Examples of passive include stock dividends or savings interest, tenant payments from rental property, or royalties from intellectual properties (such as a patent for an invention or from publishing a book).

There are only two variables involved in the active income calculation: time and rate.

In order to increase your active income, you can work more hours or get a raise to increase your rate. While theoretically, your rate has no limit, it is highly unlikely you will find a job that pays significantly more than the market rate for pharmacist labor. As for time, we know for a fact that a finite number of hours exist each week (168 hours to be exact). After sleep, we are left with 112 potentially workable hours. At a market rate of $50/hour, the maximum amount a pharmacist could make in active income each week would be $5,600 (or $291,200/year). While $291,200 a year sounds pretty sweet, I would strongly advise against working every hour you are not sleeping.

Income-Active calculationThe formula for passive income gets a little trickier, but this is where financial fun begins. Passive income is not limited by the number of hours in a day and it also does not care what your salary is as a pharmacist. The total passive income you earn is dependent on the number of investments and the income produced from each investment. The good news is that both of these variables are unlimited.

For example, imagine you purchased two rental properties and also invested in stock of a company that pays an annual dividend. The first property earns you $5,000/year in rental income, the second property earns $10,000/year, and the stock dividends average $5,000/year. Your passive income is simply the sum of all returns from each investment, or in this case $20,000/year.

Income-Passive calculationSo what is the limit on passive income? The beauty of it is that you are only limited by your own imagination. Can you build an empire with a hundred different properties, businesses and investments that earn income? Yes. If it was easy to build passive income then everyone would do it. Unfortunately, establishing investments and building revenue streams typically requires a component that most new graduates just don’t have right out of school: cash. If your goal is to earn $50,000/year in passive income and your total portfolio earns 5% annually, then you will need at least $1,000,000 invested. I’m guessing if you already had $1,000,000 in cash you would not still be reading this post.

[1] Morgan J. Passive or Active Income: Are You Working For the Wrong Income? Savingadvice.com. August 31, 2008. Available from http://www.savingadvice.com/articles/2008/08/31/102272_passive-active-income.html. Accessed January 16, 2014.

[2] What is earned income? Internal Revenue Service. January 2, 2014. Available from http://www.irs.gov/Individuals/What-is-Earned-Income%3F. Accessed January 16, 2014.

Digiprove sealCopyright secured by Digiprove © 2015 A & J Consulting, LLC
Joey
Joey Mattingly, PharmD, MBA is an assistant professor at the University of Maryland School of Pharmacy located in Baltimore, Maryland. Joey has managed retail and long-term care pharmacy operations in Kentucky, Illinois and Indiana. Leading Over The Counter is a blog of Joey's views and opinions on the topics of pharmacy leadership and management and do not represent the University of Maryland, Baltimore. Joey can be followed on Twitter @joeymattingly.

Leave a Reply Text

Your email address will not be published. Required fields are marked *

Time limit is exhausted. Please reload CAPTCHA.

All original content on these pages is fingerprinted and certified by Digiprove