What Is Residual Income and How Do You Make It?

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Residual income is the money you have left after your bills are paid. Another term for it is discretionary income — fitting, because residual income is yours to do with what you want. Ideally, you’ll use it to shore up your finances, improve your credit and build wealth.

See: How To Build Your Savings From Scratch

What Is Residual Income and How Does It Work?

Residual income is your net income after you’ve paid all of your essential expenses.

If you’re like most American adults, your paycheck, which already has taxes taken out, goes into your checking account, and you use that account to pay your bills. Some of those bills are mandatory expenses, such as your rent or mortgage, utility bills, insurance premiums, loan payments and minimum payments due on credit cards. Because they’re the most important bills, you probably pay them first and make sure you have money left for groceries, gas and other variable expenses as well.

If you still have money in your account after all these expenses, you’ve got residual income. It’s the portion of your income that remains after you’ve paid your necessary expenses, and you have discretion over how you spend it.

Is Residual Income the Same Thing as Passive Income?

No. Residual income is the money you have left after you’ve paid your necessary bills. The source of that income doesn’t matter. Passive income, on the other hand, specifically refers to income generated by activities that require little effort once they’re up and running. Real estate investments are a prime example. It takes work to search for and then buy an investment property and get it ready to rent, but once that’s done, you can hire a property manager to maintain the property and communicate with the tenant.

Why Does Residual Income Matter?

On its own, income doesn’t say much about your financial health. For example, a $1 million salary sounds enormous, but if the earner also has $1 million in necessary expenses, it doesn’t mean much. That’s because how much you make matters less than how much you keep. Here are some of the benefits of residual income:

• It helps you qualify for loans. Your ability to make loan payments depends on having cash available after you’ve paid your other bills, so the more residual income you have, the more qualified you are to borrow.
• It makes your finances more resilient to setbacks. Spending everything you earn leaves no spare cash to get you through a financial emergency. Relying on credit cards and loans to get you through makes a bad situation worse.
• It puts important financial goals within reach. Saving for important financial milestones like buying a home or retiring early is impossible if you have no money left at the end of the month. Residual income makes these goals possible.
• It gives you the freedom and flexibility to create a lifestyle you enjoy. While discretionary money can’t buy happiness, it can buy you access to travel, entertainment, hobbies and other activities that are out of reach to individuals who have no cash to spare.
• It reduces stress. Few things are more stressful than having more expenses than you have money. Knowing you can pay your bills with money to spare relieves you of that anxiety.

How Do I Figure Out How Much Residual Income I Have?

A simple formula tells you how much residual income you have:

Residual Income Formula

Income – Necessary Expenses = Residual Income

Here’s how to calculate it:

1. Determine your net (after-tax) monthly income from all sources.
2. List all of your necessary expenses, like rent or mortgage, car payment, minimum credit payments, health insurance and transportation, and add them up.
3. Subtract your necessary expenses from your net income. Your residual income is the amount that remains.

Take, for example, someone who earns $5,000 per month after taxes. If they spend $3,000 each month on essential expenses, their residual income is $2,000.

How Should I Use My Residual Income?

The best uses for residual income include generating more income and growing and preserving wealth. You can do this by:

• Establishing an emergency fund
• Paying down debt
• Making maximum contributions to your 401(k), especially if your employer matches your contributions, and individual retirement account
• Socking away money in a high-yield savings account, money market account or certificate of deposit
• Investing in income-producing dividend stocks
• Investing in education to improve your skills and job prospects
• Starting a business

You don’t have to use all of your residual income to improve your finances. In fact, Fidelity recommends doing something fun with your extra cash. “Celebrating wins with smaller incentives, such as a fancy dinner out or a weekend away, can help reinforce your good habits and motivate you to keep making wise money decisions over time,” according to Fidelity’s Smart Money blog.

What Are the Fastest Ways To Increase My Residual Income?

There are only two ways to increase your residual income: earn more income or reduce your necessary expenses. You could see quick improvement with either option.

Earn More Income

You can earn more income by either finding additional sources of income or increasing the income from sources you already have.

• Ask for a raise: Be ready to communicate your value and contributions to the company.
• Change jobs: According to a 2022 Pew Research Center poll, 60% of workers who changed jobs between April 2021 and March 2022 increased their real earnings by an average of 9% compared to the same month the year before. Those who stayed with the same employer saw their real earnings fall 7%.
• Take a side gig: It seems like there’s a side gig for just about any skill these days, and some of them pay as much as a regular job. Rideshare and delivery driving have especially good earning potential because you can be active in multiple apps at the same time — a strategy called stacking.
• Start a rental business: If you have something lots of people want, you can generate regular income by renting it out. Examples run the gamut from your kids’ outgrown baby gear to your bicycle, boat, RV, space in your home or garage — even your swimming pool.

Reduce Necessary Expenses

Despite the fact that necessary expenses are, well, necessary, any bit you can shave off their cost increases your residual income.

• Shop for lower utility rates: Your local electric choice program might have suppliers with lower rates than you’re currently paying.
• Negotiate your bills: Name a bill, and there’s a negotiating service that claims they can reduce it. Some popular ones include BillCutterz and Trim. However, you can save yourself the fees and negotiate reduced rates for everything from your wireless bill to rent and your children’s private-school tuition.
• Downsize your home: This is a big step, and it’s not a fast one unless your lease is about to expire. But housing is probably your largest expense, and you can increase your residual income by hundreds of dollars per month by downsizing.
• Give up your car: Car payments, registration fees and repairs really add up. If you live in a city — or are a two-car household that could reduce to one — getting rid of your car might leave you with thousands of dollars in residual income each year.

Managing Your Residual Income

Creating a budget is a great way to manage your residual income. By keeping tabs on money coming into your household and staying mindful of how you spend it, you can maximize the value of your earnings and use it to build lasting wealth.

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