If you’re looking for a way to generate some extra cash, then you might like the idea of earning some “passive income”.
Get it right, and you could find yourself with a reliable income for years to come – and in theory it should be achieved without having to put in a vast amount more work.
Here, Telegraph Money explains what passive income is and gives some examples of how you could make it.
Passive income refers to a source of money you earn that you don’t have to actively work for. That’s not to say that you won’t need to put in some serious time and effort in the beginning to set it up, but once that’s done it should continue to provide you with an income that’s separate from your job.
Megan Rimmer, chartered financial planner at Quilter Cheviot, said: “Passive income refers to earnings generated from sources that require minimal involvement once they’re set up.”
These are still popular but tend to require you to put up more money to start things off.
More recently, all sorts of people from different age groups and income groups are coming up with increasingly creative ways of making passive income.
While a passive income stream can be pretty easy once it’s set up, it does require a lot of planning and preparation beforehand.
You could well have more than one source of passive income, but you’ll need to have a think about which methods will suit you and bring in enough money to be worth the initial effort.
There are lots of options for making passive income – some will depend on how comfortable you are, or whether you have a creative talent that people might pay for.
Here, we detail some of the ways to make passive income that could be considered by almost anyone.
Investing can be an accessible way to earn a passive income and can be especially valuable if you make use of tax-efficient individual savings accounts (Isas). With an Isa, you can invest up to £20,000 annually and returns are free from both capital gains and dividend taxes.
This tax efficiency has grown even more important given the announcement in the recent Budget of a reduction in the capital gains tax allowance.
Ms Rimmer said: “This highlights the benefits of an Isa for those seeking to grow passive income without being taxed heavily.”
You just need to bear in mind that investments also carry their own risks and are subject to fluctuations. This underlines the importance of having a diversified portfolio.
More specifically, look into putting a lump sum into stocks or funds that pay a dividend. This is a distribution of earnings to shareholders from the company they’re invested in, which tend to be paid quarterly – and you can usually choose to receive it in cash. If you choose to do this, you won’t benefit from the compound interest of other investing income, but it is an easy way to arrange a regular source of income.
Unless the investments are held in an Isa, you’ll pay tax on dividend income above £500 in 2024-25.
Investing in property was once a popular way to generate passive income through buy-to-let arrangements. However, recent tax and regulatory changes mean it’s not so easy to make big profits – including the removal of mortgage interest relief and the 5pc stamp duty surcharge on second homes.
Ms Rimmer said: “Such moves have made it much harder to turn a profit in this space. While some landlords may still succeed, it’s now a much riskier and more complex path.”
If you don’t have a second home, but do have spare room, taking in a lodger is another option. Under current rules, you can earn up to £7,500 a year letting a furnished room without having to pay tax on it. This is thanks to the “rent-a-room” scheme.
If you earn more than this, you are required to complete a tax return.
You might also choose to rent out your parking space or any other space for storage. Note that you get up to £1,000 each year in tax-free allowances for property income.
If you’re not keen on investing in a physical property, a real estate investment trust, or REIT, might be a better way to capitalise on the sector.
REITs are closed-ended funds, which have a fixed pool of capital that is not affected by investors buying and selling. This protects them from the issue of “liquidity mismatch”, when managers are unable to fulfil redemptions if investors rush to cash out – as was seen during the Covid pandemic.
Simple as it sounds, earning interest on savings is a form of passive income.
The key here is to look around for the highest rates you can find, as this will mean you’re making the most of your hard-earned cash.
Telegraph Money’s guide to the best savings accounts is updated weekly with the best deals.
To keep a stream of money coming in, you could set up a “bond ladder”. This involves splitting up your savings into several groups and depositing each one into a bond that is due to mature at a slightly different time – you could split them out to give yourself a payout once a year, or more often if you’re willing to keep track of lots of accounts.
When each bond matures, you can “pay yourself” the savings interest, and then re-invest the money into a different account, and so on.
Passive income is defined as income derived from a source which you play no role – or only a very minimal role – in obtaining.
David Hunter, wealth planner at Succession Wealth, said: “It can be further characterised by its flexibility because it does not require active participation, allowing you additional freedom.”
This contrasts with active income, which needs ongoing time and effort.
Mr Hunter said: “This involves you playing a more pivotal role – such as employment or self-employment. The main difference being that if you were to stop the activity, the income would also likely stop.”
Yes, you can – and lots of people do.
Many people in Britain live a life that is entirely funded by passive income streams.
But be under no illusion. Almost every venture requires a huge level of work and effort to get going.
You only get to reap the rewards and collect income “passively” a lot further down the line, so don’t be too hasty about throwing in the towel on the day job.
A sensible approach is to start your passive income venture as a side hustle. That way, you’ll have the security of a regular income while you work out whether you can get it off the ground.
While passive income can provide financial freedom by de-linking earnings from hours worked, it’s rarely as simple as it sounds.
Creating meaningful returns generally requires upfront effort, capital and a willingness to accept risk – especially with avenues such as property and stock markets, as both can fluctuate.
Ms Rimmer said: “In this respect, building passive income often requires a carefully planned approach that accounts for risk – and aligns with long-term financial goals.”
You also need to tread very carefully online.
Jason Witcombe, chartered financial planner at Empower Partners, said: “As passive income can be presented as trying to generate ‘money for nothing’, it’s no surprise that the internet is full of advice on passive income ‘side hustles’ or ‘get-rich-quick’ schemes. Just be careful who you believe, otherwise you could find yourself being someone else’s passive income.”
Sadly there is no simple answer to this.
Mr Witcombe said: “There are ‘infinite’ ways you can generate a passive income – so it’s impossible to say which is ‘best’.”
The most sensible approach is to research the various ideas carefully to see which ones might work well for you. Always go in with your eyes open, fully aware not only of the rewards on offer – but also of the potential risks involved.
Don’t base your decision on what has worked for other people – you need to consider your own situation.