Unearned income

Unearned income refers to income received from sources other than employment or active work, such as investments, rental properties, interest, dividends, and inheritances.
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Updated: May 30, 2024

3 key takeaways

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  • Unearned income includes earnings from investments, rental properties, interest, dividends, and inheritances.
  • It is distinct from earned income, which is derived from employment or active work.
  • Unearned income is often subject to different tax treatments compared to earned income.

What is unearned income?

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Unearned income is a type of income that individuals receive without directly working for it. Unlike earned income, which is obtained through employment, self-employment, or other forms of active work, unearned income comes from passive sources such as investments, property, and other financial assets. This type of income can provide financial stability and growth opportunities, especially when strategically managed and invested.

Examples of unearned income

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Unearned income can come from various sources, including:

  • Interest: Income earned from savings accounts, certificates of deposit (CDs), bonds, and other interest-bearing accounts.
  • Dividends: Payments made by corporations to shareholders out of their profits. These payments are typically made on a regular basis, such as quarterly or annually.
  • Capital gains: Profits realized from the sale of assets such as stocks, bonds, real estate, and other investments. Capital gains are classified as short-term (assets held for less than a year) or long-term (assets held for more than a year).
  • Rental income: Earnings received from renting out property, such as residential or commercial real estate.
  • Royalties: Payments received for the use of intellectual property, such as patents, trademarks, copyrights, and natural resources like oil or minerals.
  • Annuities and pensions: Payments received from investment products designed to provide a steady income stream, often used for retirement planning.
  • Social Security benefits: In the United States, Social Security benefits can be considered unearned income for retirees who receive monthly payments based on their previous contributions to the system.

Tax treatment of unearned income

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Unearned income is often subject to different tax treatments compared to earned income. Tax rates and rules vary by country, but some common distinctions include:

  • Tax rates: In many countries, unearned income such as capital gains and dividends may be taxed at different rates than earned income. For example, long-term capital gains often have lower tax rates compared to ordinary income.
  • Tax exemptions and deductions: Some forms of unearned income may qualify for tax exemptions, deductions, or credits. For instance, certain interest income from municipal bonds may be exempt from federal income tax.
  • Reporting requirements: Unearned income must be reported on tax returns, and specific forms or schedules may be required to accurately report this income.

Importance of unearned income

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Unearned income plays a significant role in financial planning and wealth management:

  • Passive income: Unearned income can provide a steady stream of passive income, reducing reliance on earned income and offering financial security, especially in retirement.
  • Wealth accumulation: Investing in assets that generate unearned income can lead to significant wealth accumulation over time, helping individuals achieve financial goals and maintain their standard of living.
  • Diversification: Unearned income sources contribute to a diversified income portfolio, spreading financial risk and enhancing overall financial stability.

Understanding unearned income is crucial for effective financial planning and investment management. For further exploration, topics such as investment strategies, tax planning, and retirement planning provide deeper insights into optimizing unearned income and leveraging it for long-term financial success.



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Arti
AI Financial Assistant
Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.