Planning to live off the interest earned from money you have in the bank depends on the type of lifestyle you want to live. Once you figure out how much money you need each month, you have a starting point. Yet, different variables come into play when considering how much of the interest you can spend and how much needs to stay in the bank. Your lifestyle, the rate of inflation and your tax bracket all affect the amount of interest that's wise to spend without jeopardizing your capital.
Assessing Your Needs
Figure out how much money you need each year to sustain your lifestyle. Look at your bank statements and credit card statements to figure out where your income is going. Make a list of all of your current debts and subtract them from your current income. See what you have left over. Remove debts that are close to being paid off to get a more accurate estimate of what you need. For example, if your monthly mortgage payment of $1,200 will be paid off in two months, take $1,200 off of the total you need each month. If you know you can use the $1,200 per month on other expenses -- travel or hobbies -- don't take the amount off the total. The idea is to figure out how much in interest earnings you need access to each year to live your desired lifestyle. Always allow yourself more than what you actually need, in case your expenses fluctuate. To provide yourself with a financial cushion, build your interest. Ideally, you need to have three to six months of living expenses at your disposal, after you deduct your current living expenses, without eating into your capital.
Calculating Potential Interest
When you put your money in the bank, you can choose a savings account, certificate of deposit or deposit it in a money market account. All of these options pay different amounts of interest. They also have different pros and cons. CDs require the most maintenance and tie up your funds for months or years at a time -- unless you want to pay a penalty for early withdrawal. Shop around for the best interest rates, no matter where you decide to place your funds. To compare potential interest earnings each month, convert the interest rate to a decimal by moving the decimal point two places to the left. Divide the decimal figure by 12 and multiply by the amount of money you have in the bank. For example, if you have $2 million in savings accounts with an annual percentage yield of 2.2 percent, your calculation looks like this (0.022/12) * 2,000,000 = 3,666.66 in interest per month. Annually, your interest earnings equal $44,000 per year. Standard savings accounts typically yield the lowest amounts of interest. Check into other options to find a rate of return that works best for your needs. Also, interest may be compounded. Ask your bank how often and by what method interest charges are assessed to figure your actual interest earnings.
Protecting Your Capital
If you have $2 million in the bank and you earn $44,000 per year in interest, spend less than what you earn. Spending less can help you build a financial cushion and keep up with inflation and taxes. What $44,000 per year can do today won't likely be the same five years from now. For example, in 2006, the rate of inflation was 2.4 percent. In 2011, it was 3.0, an increase of 0.6 percent. Between 2001 and 2011, inflation rose to a high of 4.1 percent in 2007. If you provide yourself a cushion of 5 percent each year, you should be able to keep up with the rate of inflation. Five percent of $44,000 equals $2,200, which nets you $41,800 to spend for the year. Also, you have to consider the taxes you owe each year on interest income. Taxes will decrease the amount of interest income you have at your disposal. The amount of tax you pay depends on your specific tax bracket.
Food for Thought
Building a cushion equal to three to six months of living expenses probably won't happen overnight. Consider cutting back on non-essentials for a few months to a year to build the cushion. For instance, if you eliminate a bill, such as a mortgage, allocate that money toward your cushion each month. Once you build the cushion, you can stop allocating the money toward the cushion and use it however you would like. According to the Federal Deposit Insurance Corporation, the standard insured amount of deposit, per insured bank and depositer, in each account ownership category, is $250,000. You can deposit more than $250,000 per account in one bank, but each account must have a different ownership category. You also must meet the ownership qualifications for each account. Check with your bank to learn the requirements. Also, the separate branches of a bank do not qualify as separate banking institutions.
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