Earned income

Definition

Earned income refers to the money received for work performed, including wages, salaries, tips, bonuses, and self-employment income. This type of income is crucial for financial planning, as it often forms the foundation of an individual's overall earnings and can influence budgeting and spending habits. Understanding earned income is essential for tracking financial health and setting realistic financial goals.

5 Must Know Facts For Your Next Test

1. Earned income is subject to federal and state income taxes, as well as Social Security and Medicare taxes.
2. Many financial strategies focus on maximizing earned income through career development, education, and skill enhancement.
3. Self-employed individuals need to track both their earned income and related expenses carefully to ensure accurate reporting and tax compliance.
4. Earned income can impact eligibility for certain tax credits and benefits, such as the Earned Income Tax Credit (EITC), which is designed to assist low to moderate-income workers.
5. Understanding the distinction between earned and unearned income helps individuals make informed decisions about investments and savings.

Review Questions

• How does earned income impact an individual's financial planning process?
  • Earned income plays a significant role in financial planning as it is typically the primary source of cash flow for most individuals. By understanding their earned income, individuals can create budgets that account for necessary expenses while allowing for savings and discretionary spending. Additionally, since earned income is taxed differently than other forms of income, it is essential for individuals to consider its implications on overall tax liabilities when making financial plans.
• What are the key differences between earned income and unearned income, and why are these distinctions important for financial management?
  • Earned income is generated through active participation in work, while unearned income comes from investments or other sources without direct labor, such as interest or dividends. Understanding these distinctions is crucial for financial management because they have different tax implications and affect cash flow differently. Earned income can lead to opportunities for growth through skill development, while unearned income may provide passive revenue streams that can be leveraged for long-term wealth accumulation.
• Evaluate how tracking earned income can enhance an individual’s ability to achieve long-term financial goals.
  • Tracking earned income allows individuals to understand their earnings trajectory over time, which is vital for achieving long-term financial goals. By monitoring fluctuations in earned income due to job changes or promotions, individuals can adjust their savings strategies accordingly. This proactive approach enables them to allocate funds toward retirement accounts or investments that align with their goals. Moreover, consistent tracking of earned income aids in making informed decisions about education and career development opportunities that could increase future earnings potential.

Related terms

Net Income: The amount of money remaining after all deductions, such as taxes and benefits, have been subtracted from total earnings.

Passive Income: Income earned with little to no effort involved in generating it, such as rental income or dividends from investments.

Gross Income: The total income earned before any deductions or taxes are applied, representing the overall earnings from all sources.