If you have squirreled away a nest-egg you may be wondering now: Can I live off interest on a million dollars?
Depending on how much interest you can earn, your cost of living, and any other sources of income, you may well be able to hang up your boots and retire comfortably.
But before handing in your resignation letter to your boss and buying flip flops for your celebratory trip to a sun-drenched beach, run the numbers.
How Much Interest On A Million Dollars You Can Earn From A Savings Account:
The amount of interest on a million dollars that you can earn depends very much on where your money is parked.
Bank Savings Accounts
If the million dollars is in a bank savings account, you may only earn a pittance.
For a decade after the 2008-09 stock market crash, interest rates on money stashed in savings accounts earned next to nothing.
It wasn’t until Fed rate hikes years after the bear market that pensioners and retirees could pocket a little extra cash but even then an extra 0.50% → 1.00% doesn’t move the needle a whole lot.
Individuals weren’t the only ones stuck in the mud earning peanuts on savings, pension funds too were spinning their wheels for years.
Typically, pension funds project growth of 5% or more annually, so a decade of low rates caused pensions to suffer in states like Illinois and California.
For risk-averse investors, who want to preserve capital yet still want to earn interest on a million dollars, certificates of deposit are often a better bet.
Certificates of Deposit
If your cost of living is low, you may be able to live off interest on a million dollars invested in certificates of deposit.
At the time of our research, many of the top banks were paying just shy of 3% annually on 5-year CDs.
This means that you can earn close to $30,000 per year by locking up your money for a 5 year term.
Unlike a bank savings account that is liquid, a certificate of deposit ties up your money for a fixed duration.
So, if you plan to retire soon and will need access to your money, a CD may not be the best choice for the entire amount.
On the other hand, if you have some time on your side, a CD ladder may be a great option to provide liquidity down the road while earning decent interest rates.
How a CD Ladder Works
A CD ladder works by investing your money over different time lengths.
Imagine for a moment that you invested your $1 million into CDs exclusively.
Rather than invest all your money in a 6-month CD, 1-year CD or 5 year CD, you could spread your money equally across certificates of deposit with different durations.
For example, you could place $200,000 in a 1-year CD, and an equal amount in a 2-year CD, 3-year CD, 4-year CD, and 5-year CD.
Then when the shortest term certificate of deposit matures, you could invest the money in a new 5 year CD.
Repeat the process as each CD matures, and each year you will earn the maximum interest rate on a 5-year CD while keeping your funds much more liquid – because each year $200,000 is available to re-invest or dip into as needed.
How Much Interest On A Million Dollars You Can Earn From Investing:
If you are on the verge of retiring, bank savings accounts and certificates of deposit may be top of your bucket list when it comes to earning interest on a million dollars because the risk to your nest-egg is very low.
For individuals with a longer timeline to retirement, investing offers more reward potential but also more downside risk.
Usually a combination of stocks and bonds are a wise bet with an increasing weighting towards bonds as you get older.
But what types of stocks and which bonds?
Which Stocks Should You Buy?
Shark Tank’s Mr. Wonderful has stated that a combination of dividend-paying stocks and corporate bonds provide an optimal mix.
As Kevin O’Leary, aka Mr. Wonderful, points out, the only way to make money on such stocks is when someone else is willing to buy your shares at a higher price.
Even more significantly, Professor Siegel from the Wharton School of the University of Pennsylvania points out that 95% of the total stock market return over most of the last century came from reinvested dividends.
So, if you know wealth accumulation largely stems from dividend-paying stocks, why chase the latest trend?
Which Bonds Should You Buy?
So you know which stocks to buy now, but which bonds are best?
Government bonds are favored by many institutions because they are perceived to be low risk.
In fact, governments have a history of defaulting on bond issuances, which is why some financial advisors recommend individuals choose corporate bonds instead.
Unfortunately, there is no risk-free bet as companies are known to run into financial difficulties too from time to time.
But when you buy corporate bonds of companies with rock solid balance sheets, meaning high levels of cash and low levels of debt, and who have a global presence like Coca Cola or Apple, you stand a good chance of recouping your principal and earning a handsome fixed income yield along the way.
The takeaway is that a combination of dividend-paying stock and corporate bonds has the potential to pay you a higher yield than CDs, often as much as 3 → 5% annually for conservative portfolios in addition to any upside from rising share prices or bond prices.
How Long Will A Million Last Me?
By spreading your money across a bank savings account, certificates of deposit, dividend-paying stocks, and corporate bonds, you may be able to earn between 3% → 5% annually.
Let’s split the difference and pick a 4% yield which would translate to $40,000 of income annually.
But how long will a million last you when earning $40,000 each year?
The answer depends on your tax rate and spending.
Taxes: The Silver Lining
The income you earn in retirement may be less than your salary during your working years, resulting in lower payments to Uncle Sam when you finally hang up your boots.
Even after you factor in income from social security and interest in your nest-egg, you may still qualify for a tax break, which keeps more income from savings and investing in your pocket.
Spending: Track Your Expenses
If you feel like you are struggling to keep up with expenses, download the Personal Capital app from the AppStore if you have an iPhone or iPad, or Google Play Store if you have an Android device.
You can easily track your spending, income, net worth and even your investments in one place.
It’s a good way to spot where your money is going and whether too much is spent on say groceries, entertainment, mortgage, or utility bills.
Make sure to track your expenses over a period of 3 → 12 months, not just weekly or monthly, in order to get a more accurate assessment of your yearly costs.
On any given week you may be on track, but over the course of a year, spikes in spending crop up.
Taxes on homes, presents, vacations and insurance bills often arrive infrequently but have a meaningful impact on your overall spending.
So, it is worth viewing your spending over a long duration to gauge it more accurately.
Provided your after-tax income is greater than your spending, you should be able to sustainably live off interest on a million dollars if all else remains equal.
But what else do you need to pay attention to before jumping on the plane to the islands?
Did You Calculate The Cost Of Healthcare?
Once you leave your job, and depending on your age, you may be required to pay for health insurance.
Look to the short-term and long-term healthcare costs when running the numbers.
If you find that the interest on a million dollars just about covers your lifestyle, it may not be enough to sustain you forever more because one day you may need to spend more on healthcare costs.
For example, you may need to pay for a nursing home or some other long-term medical care.
You can always dip into your nest-egg to pay for emergencies but remember that, by so doing, the interest you earn will be lower in the future because the principal amount will be lower.
Ideally, it is best to have a cushion between what you earn on interest and what you spend so that your nest-egg is growing each year too.
That way if a medical emergency does crop up, you will be able to afford a financial hit.
Did this article Can I Live Off Interest On A Million Dollars help you to think about whether you can afford to live off your nest-egg in retirement? Share your own financial tips, we would love to hear from you.