How to create a passive income stream

If you’re worried your salary is not enough to help you save a deposit for your first property or prepare you for retirement, building wealth through passive income is a strategy that might appeal to you.

What is passive income?

Passive income is a source of revenue that continues even after the work is complete, for example, royalties from a book or film.

We’re not suggesting you go out and write a book (not very passive) or make a blockbuster movie (not very savvy), but some of the below options do require a little effort in the beginning to then pay you in the long-term without you needing to lift another finger.

What we’ve tried to highlight here is how to make your money (that you’ve already earned) make more money (without you having to do much), so they do rely on you having some initial capital already behind you.

Some of these strategies involve an element of risk. If you are not fully comfortable with that, it might be more advisable to go down the slightly more labour intensive route of selling your stuff on eBay, setting up a side business or writing that bestseller after all.

What ways can I earn a passive income?

Here are eight strategies for creating a passive income stream:

1. 1. Switch your bank account
   2. Earn interest on savings
   3. Use a cashback or rewards credit card
   4. Buy via cashback websites
   5. Try out robo-investing
   6. Rent out a room (or parking space)
   7. Invest with peer-to-peer lending
   8. Purchase dividend-yielding stocks

1. Switch your bank account

Loyalty to your bank is a thing of the past, and banks know it. That’s why so many offer cash switching incentives (the current highest is £200 from HSBC) for current accounts, many of which link with savings accounts, some with interest as high as 5%.

Not all banks are part of the switching scheme, but those that are guarantee all direct debits and standing orders are transferred to your new account within seven days.

If they fail to do this and you wind up with a late payment charge from your old account, your new bank should cover it.

Most bank accounts have a minimum pay-in and a two direct debits requirement – make sure you meet them to reap the full benefits of the switching rewards.

Some charge a monthly fee, so watch out for that when you switch over as you do not want to pay out more than you earn.

2. Earn interest on savings

In today’s low interest climate, the best rates on savings are often reserved for fixed-rate accounts or bonds. These are savings accounts that lock away your money for a set period of time. Generally speaking, the longer it’s locked away, the higher the rate.

Only use these if you are comfortable with not having access to your money. If you suddenly realise you need it before the bond is up, you will most likely have to pay an early withdrawal fee.

One way to avoid this is to get a current account with a high interest rate as we mentioned above.

Today, the best returns on savings are from Lifetime and Help to Buy ISAs where the government pays you a 25% bonus on your funds. The Help to Buy ISA pays this on withdrawal, whereas the Lifetime ISA pays in the bonus annually.

3. Use a cashback or rewards credit card

If you are going to spend on a credit card anyway (which you may need to do to build up your credit history), you might as well get one that gives you cash bonuses to do so.

There are a few cards out there that offer cashback or that operate reward schemes that could give you discounts in certain stores or earn you air miles.

However, always approach credit cards with caution – they are a debt product after all. If you do not think you will be able to pay it back in full every month, your interest repayments will very quickly outpace any cashback or rewards.

4. Buy via cashback websites

Cashback websites are essentially third party portals that you visit before clicking through to a website from which you were already going to buy something.

Using the cashback site’s link rewards them with money, some of which they pass on to you. How much you could get is usually shown as a percentage of the total amount you spend, but you are not always guaranteed to get that amount.

Like with a cashback credit card, only use a cashback site if you were planning to spend that money anyway – that way, you really could be getting something for nothing.

5. Try out robo-investing

Robo-investing is one of the slightly riskier ways to make a passive income, especially as you cannot specify where your funds get invested.

Unlike with traditional savings accounts where your money just sits there earning (or not earning much) interest, here it gets invested so you could reap bigger financial rewards. Remember, you could also experience a loss, so proceed with caution.

Robo-investing, open banking apps like Moneybox round up your spending and invest the difference.

For example, if you bought something costing £2.80, Moneybox rounds it up to £3 and invests the spare 20p. You can pick from three levels of risk: cautious, balanced, or adventurous.

The idea is, the amounts are so nominal you do not notice them not being there – it’s like putting your spare change in a piggy bank rather than having it jangle around in your pocket.

However, if you are someone who likes to keep an eye on every penny, this may not be the best way for you to earn a passive income.

6. Rent out a room (or parking space)

Buying and then renting out an entire property is a good way to earn a passive income, but it’s an expensive one and requires a lot of work.

For starters, you’ll have to pay an extra 3% in stamp duty (if it’s your second home, otherwise you pay the normal stamp duty rates), need a 25% deposit and – if you’ve already exceeded the tax-free income threshold (£12,500 in 2019/2020) – you’ll have to pay income tax on any earnings.

However, if you have a spare room in your current property or have an empty parking space in an area where parking is an absolute premium, you can rent it out.

Again, this is something you will need to report to the tax man, but if you are not using the space, it could be a great way to earn passive income.

7. Invest with peer-to-peer lending

Peer-to-peer (P2P) lending consists of a personal loan made between you and a borrower, facilitated through a third-party intermediary such as Zopa or Funding Circle.

As a lender, you earn income via interest payments made on the loans. But because the loan is unsecured, you face the risk of the borrower defaulting on payments.

To minimise that risk, you should do two things:

• Diversify your lending portfolio by investing smaller amounts over multiple loans
• Analyse the historical data on the borrowers to make informed picks

It takes time to master the metrics of P2P lending, so it’s not entirely passive and because you’re investing in multiple loans, you’ll need to pay close attention to payments received.

Whatever you make in interest should be reinvested if you want to build income.

8. Purchase dividend-yielding stocks

A dividend is a sum of money paid to shareholders out of a company’s profits. Shareholders in companies with dividend-yielding stocks receive payments at regular intervals from the company.

Since the income from the stocks is not related to any activity other than the initial financial investment, owning dividend-yielding stocks can be one of the most passive forms of making money.

The tricky part is choosing the right stocks. To try and minimise loss, thoroughly investigate the company you’re thinking of investing in. Do not rush into anything!

If you are unsure of what to do, it might be worth speaking to a financial advisor. They will explain the risks meaning you can make an informed decision about the best course of action.

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Last updated: 18 April, 2019

What's Different Between Roth IRA vs. Roth 401(k)?

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A Roth 401(k) and a Roth IRA sound similar — and they are.

Contributions are made after taxes — meaning your taxable income isn’t reduced by the amount of your contributions when you file your taxes. But you get a tremendous tax advantage down the road, since earnings can be taken out tax-free at age 59 1/2.

Roth IRA and a Roth 401(k): 6 differences

However, the Roth 401(k) has a few key differences from the Roth IRA. Here’s what to know before deciding which account is right for you.

1. Contribution and income limits

The most distinguishing characteristic of 401(k)s, whether Roth or traditional, is the high contribution limit, allowing employees to save up to $19,000 per year in 2019. For workers over 50, the ceiling is $25,000.

Meanwhile, IRA contribution limits are $6,000, and workers over 50 may contribute up to $7,000 per year.

There are, however, income limitations for Roth IRA contributions. If your modified adjusted gross income in 2019 is $203,000 or more for married couples filing jointly or $137,000 or more for single filers, the accounts are off-limits.

There are no income limits on Roth 401(k)s.

2. Distributions

A benefit of the Roth IRA is that the account can exist, essentially, forever without any minimum required distributions.

A benefit of the Roth IRA is that there is no requirement to start taking distributions while the account holder is still alive.

Should the account holder pass away, only their spouse won’t be required to take distributions or pay taxes. Anyone other than their spouse who is listed as a beneficiary will be required to withdraw a minimum amount each year.

3. The match in a Roth 401(k)

Besides their high contribution limits, Roth 401(k)s have another advantage: The worker’s contributions can be matched by the employer up to a certain percentage. It’s essentially free money from the employer, on top of the employee’s elective deferrals.

However, if you are contributing to a Roth 401(k), your employer’s match will be placed into a traditional 401(k).

“The employer part never reaches you, so it can’t be done on an after-tax basis,” says Dean Barber, founder and CEO of Barber Financial Group.

For workers who divide contributions between a regular 401(k) and a Roth 401(k), the company match will be applied to the traditional 401(k).

4. Investment options

A Roth IRA allows investors a great deal more control over their accounts than a Roth 401(k). Investors can choose from the universe of investments for their own accounts, including individual stocks and bonds, but are limited to the funds their employers offer in a 401(k) plan.

Depending on their plan’s investment menu, employees might be better off maximizing the match from their employer and then funneling extra retirement dollars into a Roth IRA. That way they can take advantage of better investment options if the fund lineup is too limited in the employer’s plan.

Also check the expense ratios of the funds in your Roth 401(k) plan. The lower the expense ratio, the higher your return. Investors paid an average of 0.52 percent for their mutual funds and exchange-traded funds in 2017, according to Morningstar Research Services’s most recent data. If the funds in your 401(k) plan run higher than 1 percent, strongly consider investing in a Roth IRA.

5. Income limits

Roth IRA contributions are off-limits if your modified adjusted gross income in 2019 is $203,000 or more for married couples filing jointly or $137,000 or more for single filers.

Meanwhile, there are no income limits on Roth 401(k)s.

6. Rules for early withdrawals

Withdrawals from both Roth 401(k)s and Roth IRAs are tax free if they meet certain criteria:

• The accounts must be held for at least five years.
• Distributions are made in the event of disability or death or the account holder reaches age 59 1/2.

You can always take out the money you contributed to either Roth account without tax repercussions. But if you want to take out earnings as well as contributions early without paying taxes or an early-withdrawal penalty, you generally would have to take out a loan with the Roth 401(k) if the plan permits.

With a Roth IRA, you can withdraw up to $10,000 to buy, build or rebuild a first home and avoid paying taxes and the 10 percent early withdrawal penalty even if you are under age 59 1/2.

You can have a Roth IRA and a Roth 401(k)

Yes, it is possible to have both a Roth IRA and a Roth 401(k) at the same time. However, keep in mind that a Roth 401(k) must be offered by your employer in order to participate.

If you don’t have enough money to max out on contributions to both accounts, it’s recommended to max out the Roth 401(k) first to receive the benefit of a full employer match.

Roth IRA or Roth 401(k): Which is better?

Determining which account will best suit your needs depends on your current and future financial situations, as well as your own specific goals.

High earners who want to make contributions to retirement accounts each year should consider a Roth 401(k), because they have no income caps. Additionally, individuals who want to make large contributions can make almost three times the amount in a Roth 401(k) rather than a Roth IRA.

Those who want more flexibility with their funds, including no required distributions, might lean toward a Roth IRA. This would especially be helpful if you want to leave the account to an heir.

Saving for the future is important. Not sure where to start? Use Bankrate’s retirement calculators to explore your options for investing in your future.