Living Off of Interest in Retirement May Not Be a Pipe Dream Any More

One of the biggest fears Americans have with regard to retirement is running out of money. And it almost doesn’t matter whether you kick off your senior years with $600,000 or $4 million. Somewhere, in the back of your mind, there’s probably the nagging worry that if you live longer than expected or your expenses come in higher than anticipated, you could end up with no money left to your name.

Of course, a good way to prevent that scenario is to never touch your portfolio’s principal, and instead, live only on the interest income it generates. To be clear, this is different from the 4% rule.

The 4% rule has you withdrawing 4% of your portfolio’s value your first year of retirement, and then adjusting subsequent withdrawals to account for inflation. With the 4% rule, you may be withdrawing interest only, but that’s not a given, and that’s not actually the guidance. Rather, the 4% rule allows for the withdrawal of principal on top of earnings your portfolio generates.

Now the 4% rule has been studied extensively and is said to make it likely that your savings will last 30 years. Whether that’s enough for you, though, depends on your lifespan.

On the other hand, if you truly never touch your principal, you’re pretty much guaranteed to not run out of money. And in today’s environment, living on interest alone may be doable.

Why an interest-only retirement works right now

There are a number of ways your retirement portfolio can generate income. One option is to load up on dividend stocks.

But in that case, while ongoing income is likely, it’s not guaranteed. And also, your principal could shrink if the specific stocks you’re invested in lose value. So you’re not quite guaranteed to preserve your principal even if you pledge not to touch it.

Similarly, you could invest in bonds, where interest income is guaranteed barring a default. But because bond values can fluctuate — albeit typically not as wildly as stock values — there’s the potential for loss of principal there, too.

On the other hand, if you decide to keep your entire retirement portfolio in cash, you may be able to live on only the interest given where rates are at today.

Many people don’t realize just how generously high-yield savings accounts are paying right now. And if you spread your assets around, you can secure FDIC protection on your cash so that you’re effectively guaranteed not to lose out on any principal.

For example, say you have $2 million in retirement savings and are able to spread that money across high-yield savings accounts paying 4%. That gives you $80,000 a year of interest income to work with. On top of Social Security, it may be more than enough to cover your expenses.

Another option is to take your money and use it to open a CD ladder. Once again, you can protect your principal and this time live off of guaranteed interest (whereas the interest paid by a savings account can fluctuate).

Some caveats to consider

While an interest-only retirement strategy might work for some people, there are a few caveats. First, you need to have a fair amount of money saved up in the first place for your portfolio to produce enough income from high-yield savings alone.

Secondly, while high-yield savings accounts and CDs are paying 4% now, circumstances could change over time. And if rates creep back down toward 1%, where they sat for many years, this strategy probably won’t be viable.

That doesn’t mean you can’t tweak it, though. If bonds are paying well at that point, you could switch from cash to bonds and enjoy a relatively stable principal that you may not have to touch.

One thing you may want to do no matter how much savings you’re retiring with is sit down with a qualified financial advisor and talk through different strategies. But you may find that living on interest alone in retirement is doable — at least in the near term.

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