For older Americans, living off the interest and returns from your retirement account is how retirement is structured. The goal is that by the time you hit your late 60s, you’ll ideally have enough savings to ride indefinitely. For young Americans, the goal is to accumulate enough savings to retire early. But building this kind of nest egg is not easy. And when you think about how much money you’ll need to get there, you might be wondering: is $2 million enough? And can you live off the returns of a $2 million account? The answer is yes, if you’re smart about it. Here’s what you need to know.
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How to live off interest
The first thing to understand is how you live off the interest. When we talk about living off interest payments, we are referring to what is called “passive income”. This means that your various assets alone generate enough money to ensure your monthly income. You have no extra income or other work (beyond portfolio management) that adds to your portfolio or monthly budget.
Ideally, you don’t shoot the main principal either. You can, of course. For example, someone who withdrew $75,000 a year from a $2 million account could live over 25 years before the account runs out. But when we talk about living on interest, we’re trying to decide if we can live indefinitely. This means you don’t touch the principal, only interest and returns.
First step: how much money do you need?
To determine if you can live on interest from an account, the first step is to understand your own expenses. In other words, first you need to know how much money you will need each month. Then you can figure out what type of savings can get you there.
Living off interest from your savings is a great goal, and many young Americans are increasingly targeting it. The best way to start this project is to focus on debt. Nothing will erode your ability to exceed your expenses faster than the fixed monthly overhead of a credit card, student loans, or other forms of interest-bearing loans. Pay them off as quickly as possible and this project will be a whole lot easier.
When making this calculation, it is important to balance your needs and wants. First, how much money do you absolutely need per month? Do you have fixed expenses, like medical bills or other bills that can’t go away? Do you support anyone?
Next, take a realistic look at your lifestyle. What you want to do here is balance two competing needs: on the one hand, the more lavish your lifestyle, the higher your bills and the more money you’ll need before a portfolio can deliver those returns. . On the other hand, this is about being happy. Set yourself a target lifestyle that allows you to have the things you want in life, otherwise you’ll be both more miserable and more likely to blow your budget.
Get an overview of your finances and be realistic about what you want and need.
Social Security provides a stable source of income for older Americans and is a fantastic addition to almost any retirement plan. The average retiree receives about $1,650 per month from this program. We won’t include it in this article because it skews our answer to whether someone can live on just $2 million in savings. But if you plan to retire, don’t forget to include this income in your budget.
Can $2 million do that?
If you’ve saved $2 million, what budget can you live with? The answer to this question entirely depends on how you have invested this money.
Investment options for your money range from something as basic as a savings account to options like stocks, bonds, and other assets. The key issue is reliability and security. The more money an investment makes, the greater the risk of loss or at least the less volatility. If you’re looking to live off interest from an account, you need a balance:
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The investment must be safe enough to minimize your risk of loss, otherwise you will find yourself without the money you need to live on;
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The investment should be relatively stable, so you can generally know what to expect each year or over time;
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The investment must also grow enough to generate real income, otherwise you will have no meaningful return to live on.
While there are many different options, here are four of the best choices for investing in stable, long-term income:
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High Yield Savings Account, 0.60%: $12,000 income per year. A high yield savings account is literally just a savings account at the bank, but since you’ve deposited a lot of money, it raises your interest rate. Although the numbers vary, on average you can expect to find interest rates around 0.60%. It’s not a great option for generating revenue, but it’s about as solid as it gets when it comes to reliability.
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One-year Treasury bills, 1.72%: $34,000 income per year. Government bonds and bills offer a wide variety of options. Their interest rates change based on monetary policy decisions, but at the time of writing, a 12-month Treasury note offered 1.72% interest. It is the safest place in the world for your money, although returns tend to be low and the interest rate can change.
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Certificates of deposit, 1.2%: $24,000 per year. When you buy a certificate of deposit, the bank holds your money for a set period, which means you can’t withdraw it, but in return, they pay you a high interest rate. With a good bank, you should be able to get rates around 1.2%. Like a savings account, it’s about as good as it gets in terms of reliability, although even the high rate of a CD is pretty low and you can’t access your capital in an emergency. .
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S&P 500 Index Funds, 10%: $200,000 per year. Over the past few decades, mutual funds and ETFs indexed to the S&P 500 have averaged between 10% and 14% a year. Unlike the other options we’ve considered here, index funds carry real risk. With a bank product (like a savings account or CD) or treasury debt, you get an extremely high degree of confidence in both your return and your principal. The stock market is much less predictable. It fluctuates, with some years significantly above average and other years showing a loss. Nevertheless, an index fund is also the most stable high yield option we can recommend.
Why You Can Probably Live On $2 Million
Some particularly budget-conscious households could live off paying off Treasury debt at $34,000 a year. Although this is a small amount of money compared to your likely future needs. And even if you can pay your bills, there’s almost certainly no room for error.
An index fund, however, might offer you an alternative way to do this. The good news about an index fund is in the sheer numbers involved. With an average return of $200,000 a year, that’s more than enough for all but the biggest spenders to live comfortably. You can collect your returns, pay your capital gains taxes, and have plenty for a comfortable lifestyle.
The bad news about an index fund is variability. Over time, major indices like the S&P 500 return to their averages. In any given year, however, returns vary. For example, between 2012 and 2022 alone, the S&P 500 posted annual returns of 29.6% (2013), -6.24% (2018) and 26.89% (2021). Between returns of nearly triple the average, the market also spent a year shedding nearly an entire year’s average gains.
This means that over time the markets can be reliable enough to rely on, but you still need to plan ahead. If you want to live off an index fund, you can’t live paycheck to paycheck. Your budget should include setting aside money in one of the safe options like a certificate of deposit or treasury debt. This safety net must be large enough to allow you to live for a year or more with low returns, and even to replace the capital that your account has lost if necessary.
With $2 million in hand, that’s a very achievable goal. For example, you can easily set a family budget of $100,000 per year (again a very comfortable amount of money). You could take the other half of your annual returns and use them to pay taxes and build up that preventative war chest. Once this solid savings bank contains several hundred thousand dollars, enough to compensate for several years of lost income, you can reduce your contributions or start funneling any excess returns back into your index fund.
Conclusion
Can you live with $2 million in assets? The answer is yes, if you manage your investment portfolio intelligently. A common option is to invest $2 million in an index fund. But you’ll still need to make sure you have a rainy day fund, as the market can be reliable for decades but choppy over the years.
Tips to help you save for retirement
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According to the Federal Reserve, 60% of those with self-directed retirement accounts are not confident about their investment decisions. If you are one of them, why not hire a financial advisor? SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
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Relying on Social Security benefits alone probably won’t provide you with full support for your current lifestyle. But the benefits can certainly help cover your living expenses in retirement. SmartAsset’s Social Security Calculator will help you estimate how much benefit you can expect.
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And, if you want to know if you’re saving enough for retirement, SmartAsset’s free retirement calculator can help you figure out how much you’ll need.
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