There are essentially three types of income passive, earned and portfolio. When filing your income tax at the end of the year each one of these types of incomes have different taxes. This is why it is important that you completely understand the difference between each one.
Below is the definition of each one and the category they are in.
This is the simplest type of income to identify. This is income that is earned from having a job, owning a business, being involved in a business or any type of activity that you are paid for. Earned income involves wages, salary and tips.
This is the most common type of income. Earned income has a range of anywhere from 15% to 20% which adds up quickly. This type of income is also subject to various other taxes such as Medicare and Social Security. With these types of taxes earned income can be taxed up to as much as half of the gross amount of every paycheck. One big disadvantage of earned income is the total amount of deductions that can be taken. Earned income is not as plentiful as other types of income and is often referred to as “active income. Before filing your income tax it’s advised to consult a tax specialist about which types of deductions you qualify for. The more deductions you use the more you can get back on your tax refund.
Passive income is income that is earned from activities that you don’t always participate in such as business partnerships or real estate. In 1986 there were special rules that were passed regarding passive income that restricted exactly how much you can make. However, you can still earn approximately $25,000 and if your income is lower than $150,000 and also are active in real estate that gives you a passive income. This amount can range between $100,000 and $150,000. However other than this exception you are still allowed to earn between $100,000 and $150,000 in losses if there are other losses which cannot be claimed they can be carried forward until the property is disposed of. Other types of passive income including real estate can be claimed on Form 1031 if the proceeds are going to be used to purchase other properties or other forms of passive income.
This form of income comes from a portfolio which includes interest, capital gains, dividends or royalties. Each type of portfolio income is taxed differently. For example, capital gains are taxed at a rate of between 10% and 20% if held for longer than 12 months. Capital gains that are held for less than that are taxed as income. However, even though it is considered income at that point it still is not subject to Medicare or Social Security. One big advantage with capital gains is that it can be used to offset other investments. For example if one stock gained $12,000 and another lost $10,000 you could use capital gains to offset $2,000.
Category: Passive Income | March 25, 2013 | Comments Off
When you buy a stock in a company, you become a partial owner of its assets and profits. There are certain caveats to being a partial owner through a stock, but in general a stockholder is entitled to a share in the profits of a company. Dividends are one way in which a company management or board of directors can share the profits with the stockholders of a company.
Regular Dividends are Rare
Even though dividends are the easiest way in which a company may share its profits with its stockholders, companies rarely give out dividend. This is true even for companies that have a profit to share. A number of factors combine to make dividends rare and regular dividends even rarer. Some companies need all the money they have to grow, so they avoid paying dividend and reinvest the money in their own schemes. Others do not have any profit to share, so they do not declare any dividends.
The companies that pay regular dividends tend to be ones that have reached a stage of plateau as far as their growth is concerned. Such companies usually have a stable market share and business model, and do not require money to invest in new schemes.
The Attraction of Perpetual Dividend Raisers
The rarity of regular dividend paying companies makes them an attractive option for you if you want a stable dividend income. However, there is a class of companies that are known to not only pay regular dividend, but also raise their dividend with time. These companies have a stable business model that can generate income at a consistent rate, and are therefore able to increase their dividend to at least match the rate of inflation.
It has been seen in the wider market that no more than 100 companies have consistently raised their dividends over the last 5 years, and the number of companies that have consistently raised their dividends for 10 years is less than 50. In a market that contains thousands of companies, perpetual dividend raisers are a rarity. Just like other rare things, perpetual dividend raisers can also prove valuable if you invest in them.
Investing in Perpetual Dividend Raisers
When you assess a company to invest in it as a perpetual dividend raiser, you should check that the company has enough profits that it can pay out regular dividend and also raise it with time. You can check the company’s capability to pay dividend by calculating its payout ratio, which refers to the ratio of the dividends paid by a company in a year to the annual profits made by the company. As long as the payout ratio is lower than 60%, you are assured that even if the company’s profits took a tumble, it could continue to pay out its dividend.
Perpetual dividend raisers are a rarity in the stock market, but once found, such stocks can definitely assure you consistent returns on your principal. These companies can raise their dividend to match, and sometimes beat, the rate of inflation, which can add up over time to give you a very handsome rate of returns.
Dividend refers to the cash payout made by a company to its shareholders. Since a company is a profit-generating enterprise, paying out dividend is one way a company can share its profits with its shareholders, who are part owners of the company. For shareholders, investing in a company that pays regular dividend is comparable, and sometimes preferable, to buying bonds or fixed deposits. It is therefore no surprise that a lot of investors try to invest using one or the other dividend stock strategies. Let us find out how the different strategies fare in the long term.
Investing in High Dividend Stocks
Stocks that pay out dividend at a high rate, around 3%, are preferred by people who expect an income from their investment, and want as high income as possible. There are a number of challenges when you want to find companies that pay a regular and high dividend. You have to look at the company’s history to see its record of dividend payments. Normally, it is seen that established companies such as utilities pay out regular dividends to their stock holders. Utilities such as power and water
However, there are many blue chip companies that pay out regular dividend. Johnson & Johnson is one example of a large blue chip company that pays out a dividend of more than 3%. There are also some very popular mutual funds that focus just on high dividend stocks. One example is SPDR S&P Dividend ETF, which is invests only in high divided stocks, and currently owns assets worth about $10 billion.
Cashing out or Reinvesting
Once you follow a dividend investing strategy, you have to decide whether you want to reinvest your payments, or cash out. If you are a retiree who is living on his stocks income, then you would not be interested in reinvesting your dividend payouts. However, if you want to grow your portfolio with time, you can keep reinvesting your payouts in the same company, or even invest them in some growth company. This way your dividends can fund help grow your portfolio.
Dividend Investing Vs. Value Investing
Investing for dividends is one type of investment strategy, and it can be contrasted with value investing, in which we look at the future prospects of a company rather than its current dividend. It should be noted that the biggest proponent of value investing is Warren Buffet, and his company, Berkshire Hathaway, has never paid a single dividend to its shareholders. Today, the main share of that company costs around $70,000, which should tell us that value investing is not a bad strategy to follow in the long run.
However, when you want current returns on your investment, you should follow one or the other dividend stock strategies mentioned here. Dividend paying companies pay out dividend because they do not need that money to fund their growth, or are at a plateau as far as growth is concerned. When choosing high dividend paying companies, you should pick up companies that have a stable business model that would not be interrupted in the future.
The term passive income is thrown around a lot these days considering the new American Dream is essentially to quit your job and be able to work from home and make a nice living from your living room. Passive income is the holy grail of all entrepreneurship and investing. Passive incomes though have varying degrees of passivity.
Some say that running a blog is passive income. Those people likely haven’t run a blog before.
Dividend stocks, however, represent true passive income since they generate cash flow and income while you do nothing. The problem is most people fail to accumulate enough shares of dividend stocks to create enough meaningful and impactful income.
If dividends are ultimate passive income, the goal then is to grow our dividend portfolio as big as possible. The best way to do this is to utilize compounding (reinvesting) dividends and returns and to buy bulk purchases of shares at super valuable levels. Most people understand the first part in compounding and reinvesting dividends, but they put zero effort into monitoring the market and specific stocks to identify compelling times to allocate massive amounts of capital to dramatically increase positions with cheaply bought shares. This is the key to a large portfolio, allowing both of these forces to work in tandem.
If you’re ready to begin this process, then you’re at the right website. I will help you do the following over the coming days, months and years:
- Identify the best dividend stocks that will generate superior long term returns
- Identify the appropriate levels where additional capital can be unleashed to buy cheap shares
- Identify times when it might make sense to hoard cash rather than buy shares, saving the capital for better buying opportunities
- Encouraging you to build your positions rather than trade in and out of them.
Over time, you too can build an impressive portfolio that will be the anchor of your future passive income enabling you to do more things in your life than you ever dreamed before.