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In Canada, there are four types of income. This section will outline each of the four, the sources of each, and what to think about when planning ahead. They are Employment, Self-Employment, Investment, and Other.
Why are there different types of income?
The different types of income are in place to separate and match expenses and taxes with the type of activities you’re doing. Each income type is ‘siloed’, where the expenses related to that income stream can only be applied to that single stream. Each type is taxed differently, and some are more favourable than others - this is essential to planning and using money as a tool effectively. This section focuses on income, in another section, we’ll talk about expenses and another about tax.
Employment Income: The most common type in Canada, and likely the primary source for you. This income happens when you are compensated for your time and competencies put into someone else’s business. You earn a regular, likely known paycheque every couple of weeks (this includes commissions and tips) and you will receive a Statement of Remuneration Paid (T4) at the end of the year that will go onto your Personal Tax Return (T1).
Sources: The only way to earn employment income is to have a job working for a company.
Thinking: Trading time and competencies for money is by far the most common way, but there are consequences. You are responsible for showing up, trying, and restricting the things you do in your personal time to work around your employment schedule. This can be in the form of a rewarding career, an exhausting routine that you dread doing, or a means to an end. Either way, your time is being traded for money.
Self-Employment Income: If you work for yourself, or are a ‘small business’ in Canada (not employed by a company) then you’re earning self-employment income. This could be, for example: working construction on the weekends, making money off of youtube videos, for teaching grandparents how to use their phones, or for babysitting. This is usually considered ‘side’ income for Canadians (though it can also be the primary source) and is typically not predictable unless you set up and find the work yourself. You can deduct certain expenses from your income - more on this in the expenses and taxes sections.
Sources: Any skill set you have can be monetized - you can probably get paid to do it. The hard part is finding people to pay you. If you can find the work, deliver on the agreement, and get paid for it - you're earning self-employment income. I encourage you to look up “side jobs” or “monetizable skills” for ideas. There are tons out there!
Thinking: While still trading time for money, you aren’t working for someone else. While being responsive to the client, you can set your own schedules if the work allows for it. This might be really good for people wanting flexible or abnormal work times. Additionally, you gain skills, knowledge, and competencies from everything else that comes from beginning a small business - even if there are no employees, there are still the normal functions of reporting that need to happen every year so often to appropriately manage your money.
Investment Income: A very hot topic these days: real ‘passive’ income. Investment income is money that’s earned from owning something. It can be a rental property for those fortunate enough to have something worth renting, interest paid from depositing money into a high-interest savings account, or stocks/bonds that are purchased on an exchange that pay dividends. This type of income is highly sought after for those moving into retirement because it is usually cash-producing on a predictable timeline (like rent being paid monthly, or dividends being paid quarterly). Additionally, selling the asset itself at a gain or loss is considered a capital gain or capital loss - and is unique based on the use of the asset (might be good to talk to a CPA or CFP for help if you make or lose money doing this).
Sources: Rental income can come from any of the following: homes, cars, driveways, trailers, land, boats or anything else you can rent! Interest income can come from lending money (like a loan or Guaranteed Investment Certificates [GICs]). Dividend income comes from stocks that pay dividends, and capital gains can come from selling those stocks that have appreciated over time.
Thinking: Investment income is a slow and steady - and arguably a tried and true - way to increase your wealth over time. It’s typically thought of when people think of ‘saving a pile of money for retirement’, and allows you to reclaim time by not working. While it’s clear why it’s so desirable, it can take far longer than people initially imagine to accumulate enough to create a sustainable income from it. When you own shares you are legally partial owners of that company, and you gain the benefits of being a shareholder.
Other Income: By definition, Other income is income that originates from sources other than Employment, Self-Employment, or Investment. This is a catch-all place for one-offs or specially designed income. It typically isn’t something you can go out into the world and start earning right now.
Sources: In Canada, typical sources of Other income could include: lottery winnings, inheritance, pension income, Employment Insurance (EI), or Canada Pension Plan (CPP, a common monthly payment to disabled individuals or children - this is a broad one).
Thinking: Other income is unique in that it is there to support you when you cannot work or need assistance, or as a windfall (unexpected sum of money). This income is usually not sought after (other than lottery winnings and long-term pensions) but is much appreciated when needed.
Do
When it comes it income, take a look at your finances and see where most or all of it is coming from. Think about what happens if you lose that income stream - if all of it is coming from a job at a company that is closing next week, that means no more income. I want you to also take a look at other streams of income (regardless of where you’re currently at) and think about how having more than one might make your life easier (not by making more, but by diversifying the source). Further, think about ways that you might be able to take advantage of the multiple types of income to make more.