Working Smarter: How To Live off Interest
The pinnacle of financial freedom is being able to live off the interest from your assets.
Chris Scott
Contributing Writer at Tally
April 4, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
What if we were to tell you that it’s possible for you to earn enough money to cover your monthly expenses without having to work? Your source of monthly income would come not from a salary or hourly wages but instead from the interest yielded from your assets, like savings and investment accounts.
This phenomenon is perhaps the pinnacle of financial freedom. If you’re able to achieve this, you can retire without having to worry about tapping into the principal amount that you saved.
Reaching financial freedom and learning how to live off interest is not easy, but it is certainly possible. We’ll cover what it entails and the types of things you need to do with your personal finances to start working toward this goal.
The basics
Living off interest is a phenomenon that represents financial health. Under this strategy, you live only off the interest yielded from your assets.
Interest is essentially what financial institutions pay you when you leave your money with them.
A basic example of this is a high-yield savings account. The interest rates on high-yield savings accounts can fluctuate along with the federal funds rate. Let’s say, for the sake of an example, that you have $100,000 in a high-yield savings account with a 0.5% annual percentage yield (APY). After one month, you’ll have earned $41.67.
This probably isn’t enough to cover your monthly expenses, but it represents how a plan works where you strictly live off interest.
If you choose to live off interest alone, you would not touch the $100,000 principal in the savings account. Instead, you would only use the $41.67 per month to cover your expenses. The same concepts would apply to checking accounts, money-market accounts and certificates of deposit.
Though the money you earn from bank accounts may not be enough to cover your monthly expenses, there are other types of interest-bearing and dividend-paying assets and accounts that can help you meet your income needs:
Fixed deferred annuities — similar to certificates of deposit
Bonds, like treasury bonds
A financial advisor can help with this, as we’ll discuss below.
The benefits of living off interest
If you’re able to live off interest, it means you have reached financial independence. You no longer have to work or rely on other sources of income, like child support or alimony.
Of course, reaching the point of having a retirement nest egg that’s large enough to cover your annual income takes years of hard work, patience, diligence and even a bit of luck. Before you commit to this, you may want to also consider the downsides associated with the strategy.
The downsides to living off interest
Learning how to live off interest sounds like a great financial goal, but there are a few downsides that are worth considering.
One of the main downsides is that your interest yields — the amount that you earn in interest — may not cover emergency expenses. For instance, you may have enough in interest to cover your groceries, gas and other living expenses, but what if you need a new roof on your home? Or your car breaks down and you have an unexpected $10,000 repair?
If you’re going to cover these purchases, you will either need to tap into your emergency fund or make a withdrawal from your interest-bearing principal. If you do the latter, you will receive less in interest in future months. Therefore, you not only need to have enough in principal to cover your everyday expenses, but you also need to have an emergency fund as well.
A second downside is that you need to prepare for inflation. Retirees may not know their life expectancy, and they have no way of knowing what the rate of inflation will be in 10, 20 or 30 years.
Inflation has a direct impact on the cost of consumer goods. If the inflation rate is greater than your investment return rate, then you may not have enough in interest to cover your cost of living.
A third downside is that interest rates can fluctuate, which can impact how much money your principal yields. Unless you have a fixed-income account, you won’t be able to rely on steady interest income from month to month.
Lastly, you need to be mindful of when you can start taking Social Security and Medicare payouts, especially if you retire early. The earliest a person can begin receiving Social Security payouts is age 62. Additionally, unless you meet other limited criteria, you will not be eligible for Medicare until you’re 65 years old.
If you plan on retiring before this, you’ll either need to pay for your health care out of pocket or purchase your own health insurance. This disrupts your cash flow and increases the amount of money you need to cover your expenses.
How to calculate monthly interest earnings
To check how much interest your accounts are earning, look at your monthly account statements. Both paper and online versions of your monthly statement should include something like, “Total Earnings,” “Yields Since Account Opening” or “Interest Earned This Month.” You can add these figures up for your interest-bearing accounts to figure out how much you’re currently earning in interest.
If you’re trying to estimate how much you might earn in a month before you’ve received an interest payment, you’ll need to do some calculations. Determine your interest rate APY and divide it by 12. This will tell you what percentage you will earn on a monthly basis.
So for example, if your APY is 5%, you will earn 0.42% in interest each month. You can then multiple the monthly interest rate by your balance. So, if you have a $2,000 balance in the account with a 5% APY, you will earn about $8.40 in interest for the month. You can determine what you might earn even further in the future with an interest-on-interest calculation.
How to live off interest
If you’ve decided that you want to live off interest in the future, now is the time to start crafting your plan. Accumulating enough money in youraccounts can take years, so it’s never too early to start carving out a strategy that maximizes your returns and meets both your short-term financial needs and long-term financial goals.
No matter where you choose to put your money, it’s important that you remember diversification principles. Diversifying across multiple interest-earning vehicles helps protect against riskier investments, increasing the likelihood that you earn enough interest to live off of in retirement. It’s also important that you consider your goals and risk tolerance when choosing interest-bearing accounts and investments.
Also, it will be easier to live off interest if you first focus on paying off debts. By paying off your debts, you’ll be able to achieve a positive net worth. If you have more assets than liabilities — meaning you own more than you owe — then your net worth is positive.
Once your net worth is positive, there’s an increased likelihood that you won’t need to take on future debt. In turn, you won’t need to pay interest. You can reinvest the money that you would otherwise spend on interest, thereby aiding your retirement efforts.
If you are going to live off interest in retirement, you’ll ideally have all of your debts paid off. This includes things like:
Home/mortgage loans
Auto loans
Personal loans and lines of credit
Credit cards
Should you find that you need more help crafting your investment portfolio, consider using the resources offered by a trusted wealth management firm or financial advisor. These individuals will look at your current assets and retirement savings and can help you come up with a financial plan and investment strategy that meets your goals.
They can also help you come up with the target lump sum that you’ll need in your retirement nest egg to be able to live exclusively off interest. Lastly, once you reach retirement, they’ll help calculate your monthly interest earnings to ensure you have enough to cover your expenses.
Start managing your personal finances today
If you’re considering how to live off interest in retirement, the sooner you can get started, the better. You will not only need to have a sizable nest egg available, but you’ll also want to make sure you’re covered in the case of emergencies.
One of the first milestones in your investment and interest income strategy should be establishing a positive net worth. With a positive net worth, your assets are greater than your liabilities, and you’re less likely to have to take on debt.
If you currently have a negative net worth or are looking for ways to pay down debt, be sure to check out Tally†. Tally is a credit card payoff app designed specifically to help you pay down your existing higher-interest credit card balances quickly and efficiently with a lower-interest line of credit.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.