How much money do you need to live off interest comfortably? | Playbook (2024)

Compound interest and passive income are great ways to build your wealth, but is it possible to live solely off interest in retirement?

The typical American could replace their $40,480 annual income when they retire by investing $826,122 and living off a combination of savings interest and investment returns (assuming an average annual retirement return of 4.9%). This would cover retirement for many Americans, but it’s not necessarily true for you.

Learn how to calculate your savings goal and advice for living off interest alone for your financial future.

How to calculate interest-only living goals

The formula is relatively straightforward, but you need to identify a few important metrics first.

• Annual income goal / Annual interest rate = Savings goal

Start with your ideal future salary – how much money do you need each year to cover your expenses and lifestyle?

Then, estimate your interest rate based on the types of assets you’re investing in. These vary year-to-year, so use the lower value if you’re working with an average range.

With those two figures, you can work backward to determine your savings goal. Divide your ideal annual salary by the estimated annual interest rate, and you’ll get your savings goal.

Here’s an example using the median salary and a 4.9% interest rate:

• $40,480 / 0.049 = $826,122

In this example, you’d need to invest $826,122 to earn $40,480 in interest each year.

This investment is not a part of your future income, and withdrawing from the principal would reduce your interest income. Also note that most plans compound, so any unused income from interest can increase your invested balance and future income.

You can also reverse the formula and start with a savings amount to determine how much you’d earn in a year in interest. This is helpful if you want to see how your current savings strategy tracks, or if you want to begin with a savings goal and see if the salary is livable.

• Balance x Interest rate = Annual interest-only salary

If you’re planning to live off interest for the long term, consider the impact of inflation and evolving personal needs.

Inflation protections are particularly important since cost of living increases reduce how far your salary goes. If inflation increases more than you anticipated or it’s higher than your interest rate, you might not be able to continue living off of interest alone.

Can you live off interest?

It’s possible, but it isn’t realistic for everyone. Living off of interest relies on having a large enough balance invested that your regular interest earnings meet your salary needs.

Rest assured that you don’t need to earn a million dollar paycheck to reach your goal. Savings accounts with compound interest growth will do a lot of the heavy lifting, but it might take decades of regular contributions to get there. Investments can also earn significant returns, but they’re subject to market fluctuations that can affect your balance.

Once you have enough saved that your annual interest gains cover your expenses, only withdraw the interest earned that year. If you withdraw too much and reduce your account balance to less than your savings goal, you won’t generate enough interest to cover your expenses until you restore the account balance.

How to save enough to live off interest

Most good financial plans start with a budget to determine how much you can contribute while maintaining your lifestyle. A strong budget will also help you estimate how much you need to live off of now and how that might change in your long-term future.

Adjust your budget as you finalize your savings goals, and continue to revisit your budget over time.

Beginning to plan a life that you can live off interest alone might look like this:

1. Create a budget based on your current lifestyle and evaluate your spending habits.
2. Estimate a future salary that could cover your estimated future expenses.
3. Identify a savings goal that would produce enough interest to match or exceed your future salary estimate.
4. Establish a diversified investment strategy that meets your risk tolerance and produces high enough returns to support your goals.
5. Adjust your budget to accommodate this strategy and required contributions while supporting your current lifestyle.
6. Monitor asset performance, revisit your budget, and rebalance your portfolio to stay on track.

Estimating your future expenses and required income isn’t an exact science, so it’s better to overestimate than underestimate. It’s also wise to consult financial advisors that can help you weigh the impacts of:

• Inflation: Increases cost of living over time and may impact your future expenses and buying power
• Diversification: Balancing your portfolio asset ratio with secure, income-producing assets and riskier assets that can drive larger gains
• Tax strategy: Identifying opportunities to reduce your overall tax liability so you keep more of your money.

Can I live off interest on a million dollars?

How much you need to live off interest depends entirely on your expenses and where the balance is invested. A million dollars in a retirement account might produce enough income for the median American to get by, but you’d need larger returns to cover a six-figure lifestyle.

Consider your lifestyle goals, too. Investors planning on early retirement may get the best interest rates from traditional retirement accounts, but they can’t access the funds without heavy penalties and fees. Dividend stocks and bonds might be a better fit for early retirees.

Understand that living off interest doesn’t provide much wiggle room for emergencies or high inflation rates that outpace your annual return rate. You have to plan ahead for these situations and boost your income goals accordingly.

Here’s a comparison of how much a million dollars in a single account would theoretically earn each year:

• Annuities: 3.98% annual returns = $39,800
• Certificates of deposits: 1.39% annual returns = $13,900
• Defined contribution retirement plans: 4.9% annual returns = $49,000
• Dividend-paying stocks: 3.5% annual returns = $35,000

Of course, these are averages found over the long-term. Annual performance varies, which is why diversification is so important. For example, secure investments like CDs can counter market volatility that may negatively impact stock performance.

How to save enough for interest to support your retirement

Living off interest is a great goal for retirement, but it’s not the only way to cover your golden years. Saving millions to live off interest alone isn’t feasible for many Americans, but you can still grow a large enough nest egg to enjoy your golden years.

Here are some tips to get started:

Explore your investment opportunities.

There are several types of retirement accounts available that offer different tax advantages and perks. They are limited to withdrawal after retirement, or you risk losing some of your savings to expensive penalty fees.

• 401(k): an employer-sponsored retirement plan with pre-tax contributions
• Roth 401(k): employer-sponsored plan with after-tax contributions
• Individual retirement account (IRA): an independent plan opened with a bank or broker funded with pre-tax contributions
• Roth IRA: an independent plan funded by after-tax contributions

Employer-sponsored plans may also offer employer-match contributions. Jobs that offer this perk will match a certain percentage of your contributions up to a certain income percentage to boost your annual contributions. These funds also significantly increase your compound interest earnings.

Plan for the long term

Long-term strategies maximize your compound growth, which is the best way to increase your retirement funds. Someone who starts saving in their 20s can earn tens of thousands more than someone who didn’t start until their 30s.

Investing early also means you have more time to ride out any market volatility, so you can invest in riskier assets with the hopes of a larger payday. This is doubly effective since when you do earn and reinvest those large returns early on, they have several more years to compound.

Stick to a tax strategy

Taxes take a good chunk of income from salaries and returns on investments, which can reduce your contributions and impact your retirement income. Tax strategies are ways you can legally reduce your tax liability or defer tax payments to benefit your wealth.

Types of tax strategies you can use in your retirement planning include:

• Reduce taxable income when you contribute pre-tax cash to your 401(k) or tax-deductible contributions to an individual retirement account.
• Pay a lower tax rate and choose between Roth (taxes paid now) or traditional (taxes paid at withdrawal) retirement plans based on how you expect your tax bracket to change.
• Prioritize paying off debt with non-tax-deductible interest like car loans and credit cards.
• Take advantage of tax credits and deductions, like the Child Tax Credit or medical expense deductions.

The Playbook take

Living off interest isn’t a reality for most people, but it’s possible with enough know-how and determination.

Figuring out how much money you need to live off interest isn’t difficult, but you’ll have to estimate your future lifestyle and expenses. It’s always better to overestimate rather than underestimate, and you can always consult a financial expert for help calculating inflation or identifying tax strategies.