Passive Interest: If you are someone who loves to make easy money, then, you have to pay attention to this. It will interest you to know that though money does not grow on trees, there is money you can earn in a legal way without having to work for it. This easy money is called passive interest.
Some people earn it in various ways and varying extents. Passive interest allows many workers to reach their financial goals to retire on time, and it also helps create millionaires and even billionaires. You may want to know elaborately what passive interest is.
What is Passive Interest?
Passive interest is also called passive income. It is that earnings derived from a rental property, limited partnership or other enterprise in which a person is not actively involved. Sometimes, portfolio income is considered as passive interest by some analysts.
Passive income or passive interest has been a relatively loosely used term in recent years. Ordinarily, it is been used to define money being earned regularly with little or no effort on the part of the person receiving it.
It is also defined as the income that requires little or no effort to earn and maintain. It will interest you to know that it is also called progressive passive income when the earner expends little effort to grow the income.
There are variants of this income, this will be discussed below.
Variants of Passive Interest
Passive interest come in different variants, an understanding of these variants will also help you understand better what passive interest is all about. The following are some of the types of passive interest;
1. Self-Charged Interest
The self-charged interest deals with when money is lent to a partnership acting as a pass-through entity by that entity’s owner. The interest income on that loan to the portfolio income can qualify as passive income.
Following the IRS’s Passive Activity and At-Risk Rules, certain self-charged interest income or deductions may be treated as passive activity gross income or passive activity deductions if the loan proceeds are used in a passive activity.
2. Rental Properties
Another variant of passive interest are rental properties. Rental properties are considered as passive interest with a couple of exceptions. For instance, if you are a real estate professional, then any rental income you are making counts as active income.
However, if you are self-renting, meaning that you own a space and are renting it out to a corporation or partnership where you conduct business that does not constitute passive interest, though there are exceptions.
Also know that, income from leasing land does not qualify as passive income or interest. Despite this, a land owner can benefit from passive income loss rules if the property nets a loss during the tax year. As far as holding land for investment, any earnings would be considered active.
3. No Material Participation
Another variant of passive interest is the ‘no material participation’. This deals with when an investor puts money into a candy store with the agreement that the owners would pay him a percentage of earnings without the investor participating in the operation of the business.
Please note that there IRS standards for material participation, they include the following:
For instance, if you have dedicated more than 500 hours to a business or activity from which you are profiting, then that is material participation.
Also, if your participation in an activity has been substantially all of the participation for that tax year, then that is also considered as material participation.
Furthermore, if you participated up to 100 hours and that is at least as much as any other person involved in the activity, then that also is regarded as material participation.
At this juncture, it necessary you know that passive interest has benefits; below are some of the benefits of passive interest.
Passive interest enables an investor, a worker or an entrepreneur to save up money for the period of retirement. Thus, when you are retired, you already have saved enough money to keep you financially stable and balanced.
It Works when you do not
You will agree with me that, with your regular job, you only make money when you work. Thus, if you are sick, take a vacation, or quit, then you do not earn any money until you return to work. The importance of passive interest is that it accumulates every minute of the year.
The good thing with passive interest is that, while you sleep, your investments and savings are still earning money for you. It might not be a large amount that will allow you to quit your job today, but it is nice to know that you are getting richer by the second.
Passive Interest Has Lower Tax Rates
Though dividends paid by stocks and mutual funds are taxed at a 15% rate for most American families, passive income is taxed at lower rates than the active income you earn at a regular job.
It also Allows Flexibility
If you have a steady stream of passive interest from investments, owning rental properties, or peer lending, then you can use the income streams to supplement your current lifestyle and find a less stressful day job.
Despite the above benefits of passive interest, there some shortcomings associated or disadvantages with it. Thus, when dealing with passive interest, one has to be sensitive in handing these shortcomings.
Some Disadvantages of Passive Interest as a Retirement Plan
While there is much good that comes along with passive income, there are some disadvantages as well. Some of the disadvantages of passive interest are;
1. It Fluctuates With Interest Rates
It is pertinent you know that poor financial market conditions can wreak havoc on their portfolios. History shows that low-interest rates have made it very difficult for individuals and pension funds to grow at projected rates.
Instead of keeping money deposited in a low-risk savings account that pays 3% or 4%, retirees and pension funds need to invest in riskier assets to earn a similar rate of return.
Riskier investments often mean higher amounts of passive income in good times, but it can mean larger losses in bad times.
2. It Requires Initial Investment
Passive income also requires an initial investment. You will not earn passive income or interest by keeping spare money hidden. It needs to be deposited in a savings account, investment portfolio, or in tangible assets that can earn money once the initial cost is recouped.
At this point, you may be wondering how to curb or avert these disadvantages; please pay serious attention to the next subheading.
How to Curb or Avert the Disadvantages of Passive Interest
To avert or curb some the challenges of passive interest, you need to do periodic maintenance to ensure you are still maximizing your passive income streams. That might mean readjusting your stock portfolio to choose new funds that have lower fees or higher dividend payouts.
For rental properties, it might be installing a new roof. Anything that generates passive income should be held for its long-term benefits, not the initial and recurring costs. Take the costs into account to determine if the potential long-term payout is a good return on investment.
In a Nutshell
In a nutshell, passive interest provides you with the ability to be earnings money (either money derived from a rental property, limited partnership or other enterprise) without actively involved. Thus, as earlier observed, this is a means of making easy money in a legal way without stress.
However, you must be conscious of the shortcomings associated with it so as to avoid or curd them.