Financial Planning

What is Passive Income and How Can You Generate It?

byJeff Cuellar
  • Jul 08, 2020
  • 7 mins

It’s never too early to start thinking about your future. Whether your ultimate financial goal is to retire early and live the good life, or to be better prepared for your children’s future, the earlier you start building your wealth, the better. While putting aside some of your hard-earned pay every month is a great start to building your wealth, you’re ultimately limited by how much you can save — unless you’re able to generate passive income. 

What is Passive Income? 

Contrary to what you may have heard about passive income, it’s not about creating “set it and forget it” revenue streams that magically deliver additional income on a regular basis. It’s about investing in something that can continuously generate income with little effort. Just keep in mind that there’s no such thing as a “no effort” passive income. Such investments do require some oversight for successful returns.

How Can You Earn Passive Income? 

There are many ways to earn passive income like earning royalties by creating a digital product (e.g. mobile game, online courses, etc.) or even writing an ebook. However, there are other ways to earn passive income that may be more profitable and accessible such as investing, renting your property and signing up for retirement plans. 

Invest in Dividend-paying Stocks and Bonds

Investing in stocks and bonds maybe a great way to earn passive income through the provision of dividends — which are sums of money paid out regularly to shareholders by companies or government entities. The payout rate and frequency of dividend payment (i.e. monthly, quarterly, bi-annually or annually) for stocks are determined by the company’s board of directors. For bonds, this is determined by companies in the case of corporate bonds and government entities in the case of government bonds like Singapore Government Securities (SGS). Bonds generally have terms ranging from one year till up to 30 years and pay a coupon rate that’s the amount you can expect to receive annually as long as you hold onto the bond.

Stock dividends

So how much passive income can you earn from stock dividends? Well, that really depends on how much you’re investing in a company’s shares and the dividend yield — which is the annual dividend divided by the share price. For example, if the annual dividend is for Stock X is $2 and its share price is $40. Based on these numbers, the dividend yield for Stock X would be a respectable 5%. If you’ve invested $10,000 in Stock X and it maintained its dividend yield of 5%, your passive income generated for the year would be $500. 

That doesn’t sound like a lot now, but over time, it can grow substantially as you invest in more shares and reinvest your dividends. For example, if you invest $500 a month over 5 years into Stock X (or a diversified portfolio of stocks) and the dividend yield remains at 5%, you’ll earn $1,500 in dividends annually from your $30,000 invested, excluding any price movements of the security.

Another type of dividend stock that’s worth looking into are Real Estate Investment Trusts (REITs), which are offered by companies that own numerous commercial properties including malls, hotels, office buildings, hospitals, serviced apartments and other types of real estate. These properties earn returns, primarily through rental income — and just like stocks, dividends are rewarded to investors based on profits earned.

Bond dividends

How much can you earn from bond dividends? That depends on what the coupon rate of the bonds is.Coupon rates can be found by dividing the annual interest payments by the bond’s face value. In the case of a bond with a $1,000 face value that pays dividends of $25 bi-annually, the coupon rate would be the total dividends ($25 X 2 = $50) divided by the face value ($1,000) or 5% (50/1,000). If you buy $10,000 (i.e. 10 lots of $1,000) of bond A with a coupon rate of 2.5% over a term of 20 years, you will earn passive income of $250 a year. 


Rent Out Your Property

If you have a spare room (or even two) in your home and don’t mind living with others, it’s possible to generate passive income by renting them out. Depending on where you live (Central, East, etc.), the property type (HDB, Condo, etc.) and what amenities are provided (utilities, bathroom, etc.), you can earn up to $2,000+ a month per room. 

However, there are a few things to keep in mind if you own an HDB flat and want to rent out a room. You must have a 3-room or bigger flat and meet the HDB’s eligibility criteria. You also need to plan for an occupancy cap of six (including yourself and permitted occupiers staying in the flat) and minimum stay duration of six months for each occupant. If you own a private residential property, the criteria are slightly different. You get a permitted occupancy cap of six unrelated persons per property and minimum stay duration of three months for each occupant under the Urban Redevelopment Authority (URA)’s rules

Build Wealth with Retirement Plans

Retirement plans are designed to provide you with a steady stream of passive income during your golden years. They typically involve you paying premiums, either in one lump sum or over a certain number of years. The insurance company will then invest those premiums in a participating fund for some years and pay you monthly payouts over a designated period of time (i.e. your golden years).

Retirement plans usually give you the flexibility to choose:

  • your monthly premium;
  • your premium term – for how many years you’ll need to pay your premium;
  • the age at which you’ll start receiving payouts (e.g. 50, 55, etc.); and 
  • for how long you’ll receive these payouts (e.g. over 10, 20 or 30 years).

It’s important to be careful when choosing the premiums and terms for your retirement plan, as you should consider how much you can comfortably commit each month. The worst thing you could do is over-extend your finances and end up having to give up a retirement plan years down the road. 

To give you an idea on how to configure your retirement plan, let’s use an example of a 30-year-old non-smoker named James, who’s looking at Income’s Gro Retire Flex Pro plan. He wants monthly payouts starting from 60 years old, which is when he plans to retire. He doesn’t foresee himself needing too much money after he’s past 80, so he’s looking to receive payouts for a period of 20 years after retirement. 

(Note: The figures used are for illustrative purposes only and are rounded to the nearest dollar.)

There are two ways James can start his planning. 

Starting with how much he thinks he can afford to pay in monthly premiums, James decides to set aside $450/month over a span of 25 years (i.e. until he’s 55 years old). When he’s 60 years old, he’ll start receiving an illustrated cash payout amount of $1,564/month of which $726/month is the guaranteed cash benefit and $837/month is the non-guaranteed cash bonus, based on the assumption that the Life Participating Fund earns a long-term average return of 4.25% p.a., and this will continue for 20 years. Should the long-term average return be 3.00% p.a., James would receive guaranteed cash benefits of $726/month and the illustrated cash payout would be $1,170/month. 

Now let’s say James wants to see what he’ll have to commit to get a monthly retirement income of at least $1,200/month, with the same plan and over the same 20 years post-retirement. Working backwards, he’ll have to pay $743/month over the same period to hit his goal retirement income. The illustrated cash payout, which consists of the guaranteed cash benefit and non-guaranteed cash bonus, would be $2,583/month, based on the assumption that the Life Participating Fund earns a long-term average return of 4.25% p.a. Should the long-term average return be 3.00% p.a. The illustrated cash payout, which consists of the guaranteed cash benefit and non-guaranteed cash bonus, would be $1,933 /month. 

Since this amount is still within what he is willing and able to put aside, after careful consideration, James decides to go ahead and commit to putting aside this $743/month for retirement. 

Ready to Learn More About How You Can Earn Passive Income?  

Having a retirement focused savings plan as part of your strategy to build your retirement nest egg is an easy way to have a steady stream of passive income during your golden years. Depending on the plan and options you have selected, you can even enjoy monthly payouts up to 30 years after retirement. 

To learn more about how Income’s retirement savings plans can help you build your retirement nest egg and provide regular passive income during your golden years, connect with an advisor who can answer your questions about the plans. 

Jeff Cuellar writes about personal finance, healthcare, lifestyle, and career issues in Singapore.

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