When I meet new clients and ask how they envision their retirement, the typical response is receiving passive income in retirement. When you hear passive income in retirement, what comes to mind for you? The response I typically receive is rental income. But how passive is rental income? Okay, I am getting ahead of myself. I’ll address rental income later in this post.
Let’s start by differentiating active income from passive income.
Active Income: Examples of active income include, but are not limited to, paychecks from employers (W-2 wages), freelancing or consulting income (1099), tips, and commissions. No need to say anymore. Don’t you love it when I keep it short and to the point!
Passive Income: It is hard to classify Social Security as passive income since the amount of your social security is determined by your active income during your working years and the number of working years. But you receive social security benefits no earlier than the age of 62, and that paycheck comes to you until you pass, no matter how long you live. There is a potential spousal benefit if your spouse’s social security is less than yours. But the spouse only receives the greater of the two social security benefits. Bear in mind that this is the only inflation adjusted passive income you can receive during retirement at no additional cost to you.
Pensions are also a form of passive income. But like Social Security, the amount of income you receive from pensions is determined by the amount contributed during your working years and the number of working years. During retirement, you receive pension income until you pass, and there is an election for spousal benefits at the time of your passing. Unlike social security, you may receive annual increases in benefits from your pension but more likely than not, these increases will not keep up with inflation. Word of caution – pensions are disappearing rapidly. I hear stories often of payouts of lump sum pension benefits to employees. Why? Because the amount owed by employers to employees in the form of pension benefits is underfunded. If that is the case for you, reach out to a financial planner. You do have other options for passive income in retirement.
Speaking of other options, Annuities provide passive income in retirement. Now you do have to work for those benefits because you will need assets/money to convert to an income stream via an annuity. Way too much information on annuities for this blog post. The typical argument against annuities is complexities (I hear you!) and costly. Finding a financial planner who is working in your best interest will help overcome these arguments. Because there are annuities with no upfront or hidden fees. And there are annuities that can provide you income until the time you pass, spousal benefits at the time of your passing, and inflation adjusted payments, all for an additional cost. Yes, there is a correlation between the complexity of the annuity and its cost. Speak to a financial planner to learn more.
Did you forget about Dividend Income? Because I almost did. Dividends you earn on dividend paying stocks can be a huge addition to your retirement portfolio if you invest in stable companies that pay a lucrative dividend each year and have an excellent track record of making those payments consistently for many years. There are retirees who are living off dividend income and therefore not having to sell stocks to pay for their basic living expenses in retirement. But bear in mind, they have invested heavily into dividend paying companies/stocks over the years. As for Interest Income, another form of passive income and earned on bonds, notes and treasuries, has not been as lucrative of an option for passive income in the past several years. Not so true for this year, though! Interest income fluctuates with changes in the interest rates. But, dividend payouts can continue to be stable even in an unstable market. This year is a good example.
Now I am going to bunch several items into one paragraph as I don’t want to dwell on these items but rather just mention them. Not an all-inclusive list, by the way. These items are royalties from books, a piece of music, a patented product or a concert. Depending on where you live, you can also receive royalties for oil, gas and mineral properties. And these payouts can be quite large!
Another example would be a silent partner in a business where you provide funding but do not make decisions with respect to the business. Crowdfunding investments and investments in venture capital, private equity, real estate or other private market fund are also passive investing as you contribute money to the funds, receive distributions from the funds and are typically not involved in any of the decision making for the funds or the funds’ investments.
I have saved the most talked about form of passive income for last, and that would be Real Estate. Rental income from properties is passive income if real estate is not your trade or business. At least, that is how it is classified from a tax perspective. But I’ll tell you now, you are having to work hard to maintain that level of rental income. And if you are not working hard, someone else is at a cost of 8 to 10% of your rental income. How passive is rental income? How reliable is rental income compared to the other forms of passive income mentioned above? Everyone has a different experience with rental properties, so I cannot answer that question. But consider current high inflation for costs of repairs and updates, natural disasters, and just normal wear and tear, and how these factors are taking a huge bite out of your rental income.
There are other options for investing in passive real estate. I mentioned crowdfunding investments and investing in real estate private market funds. But there are also ways to invest in real estate in the public markets, which includes real estate investments trusts (REITs). Since real estate is one of my favorite assets to talk about, I am lucky to meet die-hard real estate fans! And the conversation is on investing in multifamily properties as they are less taxing from a time commitment perspective than rental properties and have more probabilities of consistent performance and therefore rental income than rental properties (diversifying risk between many units rather than one single rental property for a cheaper cost).
If you would like more information on annuities, be sure to check out my YouTube channel.
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