Retirement income - active v passive?

Retirement income has changed dramatically over the last 20-30 years. Most of us will have to manage our own retirement affairs, so here's a quick intro...

Up until the 1990s, it was common for people to stay with one employer throughout their career and that one employer would then pay for the worker's retirement.

With life expectancies going up and interest rates falling, the cost has become too great for many employers and many now hand the responsibility of retirement back to the worker.

In the 21st Century, you will have to take control of your retirement income.

You will need to build up your own pension and you will need to manage that. Yes, the government may subsidize us with some social security but just as ageing populations resulted in fewer final salary pensions from private employers, the changing demographics are likely to put huge pressure on social security in the years ahead, too.

Retirement income: How to earn it?

We're going to examine the two ways of making a retirement income - active and passive.

Unless you've inherited a lot of money then you'll almost certainly have to start by making active income.

Your goal should be to transition towards a passive income over your working life. Only when your passive income is covering your expenses (and you should aim for a buffer on top of this as well) will you be able to retire.

Active income:

Active income effectively means selling your time for a paycheck. For most people this means a job where you earn a salary or per hour wage.

It is active because if you don't show up to work then you won't get paid.

Even if you're a business owner then the income you earn may still rely on you being present to create those earnings.

Whilst it is possible to have huge earnings from active income (think Wall Street bankers, sports stars, or Hollywood actors), you won't be able to experience true freedom if you are reliant on your active income.

Over time you will need to save so you can build up a pot which you can use to purchase sources of passive retirement income. All other things being equal, the more you save the quicker you'll be able to retire and say goodbye to your boss.

Passive income:

This is the cash you earn off an asset and is NOT dependent on you showing up to "earn" that cash.

Let's imagine this at an extreme level.

At the moment Coca-Cola is paying dividends of $1.40 per share per year. This means that if you own 100,000 shares in Coca-Cola then you'll earn $140,000 a year. 

They will pay you that even if you don't get out of bed in the morning or spend the year travelling the world. This therefore is what most people consider the ideal retirement income.

Coca-Cola are a dividend king meaning that their dividend payments have risen every year for more than 50 years. You can read about dividend kings and dividend aristocrats here.

This website is dedicated to stocks and retiring off the dividends from those stocks but in reality there are many forms of passive income and you should look to build a collection of them.

One popular example is real estate where the passive income comes in the form of rents. If you own ten properties that pay you rent of $2000 per month, then you'll be banking $240,000 per year from your properties (pre-tax and pre-costs).

Earning interest / coupons from bonds

Unlike stocks or real estate (where dividend or rents are often raised) most bonds pay a fixed level of interest (coupon) over the life of the bond. It is possible to buy bonds that are issued from governments, corporations, or are asset backed.

Building passive income

You can either BUY or CREATE passive income.

In the examples above, you would need to buy those rental properties, bonds, or shares (unless they're given to you).

You can, however, create a stream of passive income. You could start a business and then put this under management and you get sent the dividend checks every month.

You could create copyrights, patents, trademarks, royalties, own websites, or license a name or idea.

For example it seems that English rock band Slade picks up close to $1 million every year from their 1973 song "Merry Christmas"

Similarly, 45th President, Donald Trump, likely earns significant income from licensing his "Trump" name to hotel owners around the world.

Over time, your goal is to earn as much as you can from your active income and use the savings you make from that to create or buy passive income. Ultimately it is the building of this asset pot that will enable you to retire and give you complete freedom to do what you want with your time. For more information on this then have a look at our page on living off dividends.