Can You Live Off Interest During Retirement?

By not withdrawing principal, individuals can help avoid the possibility of spending all of their money before they die. This may also enable individuals to leave an inheritance for their children and grandchildren. Whether or not this strategy is realistic depends several different factors, including:

1. How large is the individual’s investment portfolio when he or she retires?

2. How much income does the individual need to meet his or her living expenses during retirement?

Let’s look at a hypothetical example to see how living on the interest of a retirement portfolio might work.

Meet Bob and Mary

Bob and Mary have saved diligently for retirement throughout their working careers. Now in their mid-60s, they want to retire in order to spend more time with their kids and grandchildren, volunteer at a local homeless shelter, and indulge in their favorite hobbies and recreational activities.

By investing consistently and wisely, Bob and Mary have amassed a retirement portfolio that’s worth $500,000. They also made extra payments on their mortgage each month, so they own their home free and clear. And they will receive Social Security benefits totaling $2,500 a month. Therefore, Bob and Mary have determined that they will need to draw $2,500 a month (or $30,000 a year) from their retirement portfolio to meet their routine living expenses in retirement.

Given these facts, we can determine how much yield Bob and Mary will need to earn on their portfolio during retirement in order to live off of the interest and not touch the principal. Here’s the formula:

Annual amount withdrawn: 30,000
Total portfolio balance: 500,000 = .06, or 6%

So, if Bob and Mary can earn an annual yield on their investments of 6 percent, they may be able to live off of the interest generated by their portfolio and leave the principal intact.

Keep in mind, though, that this simple illustration doesn’t factor in potential taxes. Depending on the type of retirement account(s) Bob and Mary have, they may have to pay income tax on their interest, which would reduce the amount of money available to meet their monthly expenses.

What About Unexpected Expenses?

Another factor Bob and Mary must consider is the fact that they may face unexpected expenses during retirement that their normal monthly distribution will not cover. For example, suppose they were faced with a major home repair or the need to replace their automobile and needed $30,000 to meet these expenses.

If they don’t have a separate emergency fund set aside for expenses like this, they may need to tap into their principal to cover them, which would reduce their portfolio balance to $470,000. This, in turn, would increase the yield they would need to earn on their investments to 6.4 percent (30,000/470,000) if they want to continue living off of the interest.

This is a simple example, of course, and every individual’s situation will be different. But it does help demonstrate the potential opportunities and challenges of living off of a portfolio’s interest during retirement.

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA and SIPC.