Sources of Income

​Sources of Income Review

By Rebekah Williams

Income Basics

Income is money an individual or business earns or receives as the result of economic activity. It includes the money earned in exchange for providing a good or service, or received from investing capital. There are two primary types of income:

1. Earned Income

2. Unearned Income

Multiple Choice

What is the definition of income?

• Money an individual or business earns or receives as the result of economic activity.

• 
  Money received from government transfer payments.

• Money inherited from family members.

• Money an individual or business saves after paying all non discretionary expenses.

Earned Income

Earned Income is money earned from direct participation in productive activities or labor, including wages, salaries, tips, bonuses, commissions, and self-employment income. It's the most common way people make money.

Time-Based

​Wages

By law, all employers must pay employees for their work. And they do this either in the form of an hourly wage or a salary. A wage is the money paid to an employee for each hour of work provided. The total amount of wages an employee earns depends on the number of hours worked and the wage per hour the job pays. 

Minimum Wage

Many governments around the world set a minimum wage, which means the lowest legally allowed hourly wage an employee can be paid. In the U.S. the federal government sets a national minimum wage, but state and local governments also have the ability to set their own minimum wages. Employers must abide by the highest minimum wage where the employee works.

Overtime

For most hourly jobs in the U.S., employers are required by the Fair Labor Standards Act (FLSA) to provide overtime pay to employees working more than 40 hours per week, and/or more than 8 hours per day. Per the FLSA, overtime pay must be at least 50% more than an employee’s normal wage, though companies may pay more if they choose.

Multiple Choice

How is overtime pay calculated according to the Fair Labor Standards Act (FLSA)?

• At least 25% more than an employee’s normal wage.

• At least 50% more than an employee’s normal wage.

• The same as the employee’s normal wage.

• 
  Double the employee’s normal wage.

Salary

Not all employees are paid hourly. Many employees are paid with a salary, which is a fixed annual amount of money paid to an employee, normally in equal regularly scheduled increments, regardless of the number of hours worked. Most salaried earners are considered “exempt employees”, meaning they aren’t required to be paid for overtime work. 

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If a person earns a salary of $75,000 per year and is paid semi-monthly, how much is paid each pay period?

Multiple Choice

Which of the following is an example of earned income?

• Interest from a savings account.

• Dividends from stocks.

• Wages from a job.

• Rent from a tenant.

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Money earned from direct participation in productive activities or labor, including wages, salaries, tips, bonuses, commissions, and self-employment income.

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A fixed annual amount of money paid to an employee, normally in equal regularly scheduled increments, regardless of the number of hours worked.

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The lowest legally allowed hourly wage an employee can be paid.

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The money paid to an employee for each hour of work provided.

Performance-based

Salaries and wages compensate employees for the type of job role, their experience, and the quantity of time they spend working. But what about the quality of their work? Employers do often increase the salaries and wages for exceptional workers. But to motivate employees to perform beyond the expectations of a job, companies may offer commissions and/or bonuses.

Commission

A commission is money paid to an employee as a percentage of revenue they helped generate.

Multiple Choice

What type of income is a commission?

• Unearned income

• Earned income

• Passive income

• Transfer payment

Bonus

A bonus is a lump sum payment to an employee based on achieving certain performance-oriented goals. A bonus is similar to a commission because it is intended to reward employees for exceptional performance, but it may not always be tied directly to revenue or sales goals.

Multiple Choice

What is a bonus in the context of employee compensation?

• The state of working for oneself as a freelancer or the owner of a business, rather than for an employer.

• An hourly wage for overtime work.

• A lump sum payment to an employee based on achieving certain performance-oriented goals.

• Money paid to an employee as a percentage of revenue they helped generate.

Tips

Another common form of income based on quality of work are tips, which are voluntary payments given to service workers, beyond the required payment for a service, as a gesture of appreciation for their work. These “wages” are paid by consumers who were being served, not by employers. Common jobs that rely on tips include waitstaff in restaurants, hairstylists, hotel bellhops, and rideshare drivers.

Self-employment

The rise of digital platforms has opened new avenues for earning income on your own terms. Self-employment is the state of working for oneself as a freelancer or the owner of a business, rather than for an employer. This path offers flexibility and the potential to turn hobbies into income, but it also comes with challenges, like finding consistent work and managing financial instability.

Multiple Choice

What is a common form of income for self-employed individuals?

• Earnings from freelancing.

• Dividends from investments.

• Wages from an employer.

• 
  Transfer payments.

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When individuals make money from their skills and passions without being tied to a traditional employer.

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A lump sum payment to an employee based on achieving certain performance-oriented goals.

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Money paid to an employee as a percentage of revenue they helped generate.

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Voluntary payments given to service workers, beyond the required payment for a service, as a gesture of appreciation for their work.

Unearned Income

While earned income comes from working, unearned income is money received without direct participation in productive activities or labor, including interest, dividends, capital gains, rents, and retirement income. Unearned income is usually the result of “prior earned” income that was invested.

Interest

A common type of unearned income is interest. Recall that interest is the cost (or income) of borrowing (or loaning) money. To the creditor/lender, interest is the compensation for the risk associated with loaning money.

Dividends

Dividends are another form of unearned income. A dividend is a payment made by an entity to its shareholders or members, distributing a portion of its profits or reserves.

Capital Gains

A capital gain is the profit earned from the sale of an asset. Capital gains are not steady streams of cash flow like interest and dividends.

Rent

Rent is the payment made by a tenant to an asset owner for the use of property, land, or other assets, for a specified period of time.

Multiple Choice

Which type of income would a person receive from renting out an apartment?

• Earned income

• Transfer payment

• Salary

• Passive income

Retirement Income

Retirement income is another form of unearned income, usually in the form of a 401(k), IRA, or pension. These are types of retirement plans intended to pay a stream of income to retired workers, meaning those who no longer actively work to earn income.

Multiple Choice

Which of the following is NOT considered unearned income?

• Wages from a part-time job.

• Interest from a savings account.

• Dividends from investments.

• Rent from property.

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The cost (or income) of borrowing (or loaning) money.

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Money received without direct participation in productive activities or labor, including interest, dividends, capital gains, rents, and retirement income.

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The profit earned from the sale of an asset.

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The payment made by a tenant to an asset owner for the use of property, land, or other assets, for a specified period of time.

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A payment made by an entity to its shareholders or members, distributing a portion of its profits or reserves.

Transfer Payments

Another way people receive money is through transfer payments, which is a payment of money to a person where no work or service is performed in exchange for the payment. Transfer payments are distributed by the government.

Multiple Choice

What distinguishes unearned income from transfer payments?

• 
  Unearned income involves direct participation in labor or investment activity.

• Transfer payments are usually received from the government.

• 
  Unearned income does not require any prior earned income.

• Transfer payments are based on investment returns.

Examples of Transfer Payments

Social security is a government-funded program offering financial support to retirees, disabled individuals, and survivors of deceased workers. 

Social Security

One example is unemployment compensation, which are payments made by state governments to employees who lost their jobs through no fault of their own.

Unemployment

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A payment of money to a person where no work or service is performed in exchange for the payment.

Multiple Choice

Which form of income is primarily received from government programs?

• Wages

• 
  Dividends

• 
  Capital gains

• Transfer payments

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A government-funded program offering financial support to retirees, disabled individuals, and survivors of deceased workers.

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Payments made by state governments to employees who lost their jobs through no fault of their own.

​Summary

With earned income, money is received from direct participation in productive activities or labor, while unearned income is received without direct participation in productive activities or labor. And just like unearned income, transfer payments also involve the receipt of money without direct participation in productive activities or labor. The distinction is that unearned income is often the result of an investment from previously earned income, and transfer payments are usually received from the government. To be sure though, all taxpayers pay into government programs, so to that end, transfer payments, like social security, are the result of payments made into those programs. And some transfer payments can occur without having paid any money into them.

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