Author Topic: Living Off Interest in Early Retirement?  (Read 4961 times)

VioletVixen

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Living Off Interest in Early Retirement?
« on: February 14, 2015, 08:23:51 PM »
Could someone please explain to me how living off interest in ER works? Start on the day of retirement and please list steps involved. I've read many places that it's not possible, or it's risky, but obviously it must not be if you plan it right. Please enlighten me!

deborah

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Re: Living Off Interest in Early Retirement?
« Reply #1 on: February 14, 2015, 08:35:11 PM »
You have shares, bank deposits, rentals... With rentals you get rent each month. With shares you get dividends twice a year. With bank deposits you get interest as per the time period - monthly or when a term deposit matures.

These are your "interest". You use it to live off. You may also have a pension which pays you fortnightly or monthly.

iamlindoro

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Re: Living Off Interest in Early Retirement?
« Reply #2 on: February 14, 2015, 08:41:43 PM »
First off, a quick correction to terminology-- it's better to say most people will be living off the returns of their investments, since interest is just one type of way to make money on investments.

Second, there are as many ways to live off the returns of your investments as there are investment strategies.  I'll cover a few, but there are probably hundreds of ways to make this work.  These are just a couple common ones used by many people here, and most of us use a combination of at least a few of them.

1) Returns from taxable accounts.  You hold investments in an after-tax account.  This means you get paid by your employer and the employer takes out taxes, and then you invest the money.  You fund your retirement either from dividends (payments made to shareholders to share profites), gains (when you cash out the asset after it has gained in value) or both. 

2) Returns from tax-deferred investments.  You defer part of your salary into something like a 401(k) and don't pay taxes on initial investment.  When it comes time to retire, you can cash out a small amount of the investment periodically, paying taxes on withdrawal.  If you are of the retirement age, you can do this without penalty.  If you retire early, there are various strategies to "pipeline" this money out to avoid early withdrawal penalties.  The most frequently used methods of doing so are the Roth IRA pipeline and SEPP.  You can Google both these terms or search this forum.

3) Returns from Roth IRA accounts.  The Roth IRA is also an investment account.  It is funded with after-tax dollars, but grows tax-free.  Again, when you need to fund your retirement, you simply cash out whatever portion of the investment you need at whatever interval you want. 

4) Cash flow from real estate.  Many people prefer to own real estate and grow an alternative income stream through rents.  So you would invest in real estate, place tenants in that real estate, and the remainder of the rent each month after mortgage, repairs, property management, and other costs is cash flow.  Once you have enough to replace your income, or whatever amount of income you need in retirement, you are financially independent.

These are just a couple common examples.  There are so, so, SO many ways to retire early, and each person has their own strategy and comfort zone.  The above are just the most commonly seen. 

My personal strategy is a combination of real estate, tax deferred investment, and taxable investments.  Specifically, I am building cash flow in real estate to replace about 50% of my expected costs of retirement.  I am maxing out my 401(k), and putting everything left over in taxable accounts.  On retirement, I will fund the first five years with Real Estate cash flow and my taxable accounts, while filling the 5 year Roth IRA pipeline from my 401(k).  Once the pipeline is full, I can stop using the taxable account and save it for emergencies.
« Last Edit: February 14, 2015, 08:46:38 PM by iamlindoro »

VioletVixen

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Re: Living Off Interest in Early Retirement?
« Reply #3 on: February 15, 2015, 02:21:53 PM »
Thanks for the replies. I don't want to get into real estate, so I'd mainly be living off dividends from tax-deferred/Roth accounts (I don't make enough right now to max everything out, so I doubt I'd be getting anything from taxable accounts). These dividends are "cashed out" twice a year? How does this work for early retirement as far as early withdrawal penalties are concerned? Does taking the dividends ONLY count as early withdrawal?

Say I wanted to retire tomorrow. Do I have to wait until the day of retirement to start rolling over my 401k into a Roth IRA? What do I live off in the 5 year "gap" if I don't have real estate?

deborah

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Re: Living Off Interest in Early Retirement?
« Reply #4 on: February 15, 2015, 02:59:05 PM »
When you buy shares, you own a part of that company. The company announces what profits it has made regularly (generally twice a year), and keeps some of the profit to enhance the business, but gives the remainder to its owners - the shareholders. This profit is paid to you as a shareholder in the form of dividends. Different industries need to keep different amounts of profit, and you tend to find that mining companies keep more of their profits because they have more overheads, while banks keep less of their profits, so you get more dividends from a bank share than you do from a mining share (in general terms).

If you follow MMM suggestions and buy an index fund, it is made up of shares in a lot of different companies but it works similarly.

If you hold your shares in a tax reduced environment, like a 401(k) ... the whole lot including dividends is in that environment, and (generally speaking - there are some exceptions where I live, but these are not available to most people) is not available without the penalties associated with that environment - so, no you can't access it.

I had money in the bank for the time between when I could access such funds and my retirement (this is not the recommended method). Some people get an interest only housing loan for the period - which is quite reasonable given how low interest rates currently are where you live. Most people put some of their money in taxed investments for the 5 year period.

iamlindoro

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Re: Living Off Interest in Early Retirement?
« Reply #5 on: February 15, 2015, 03:11:07 PM »
Thanks for the replies. I don't want to get into real estate, so I'd mainly be living off dividends from tax-deferred/Roth accounts (I don't make enough right now to max everything out, so I doubt I'd be getting anything from taxable accounts). These dividends are "cashed out" twice a year? How does this work for early retirement as far as early withdrawal penalties are concerned? Does taking the dividends ONLY count as early withdrawal?

Yes, taking any dispersal from a tax advantaged account would be an early withdrawal.

Say I wanted to retire tomorrow. Do I have to wait until the day of retirement to start rolling over my 401k into a Roth IRA? What do I live off in the 5 year "gap" if I don't have real estate?

You'd live off taxable investments (which would require you to have some), savings, or cash out some of the 401k in addition to doing a rollover and pay the penalty on that amount.  You have to find some way to float that five years until the Roth IRA pipeline is filled up, but really any source of money will do.

Retired To Win

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Re: Living Off Interest in Early Retirement?
« Reply #6 on: February 15, 2015, 04:01:10 PM »
... I'd mainly be living off dividends from tax-deferred/Roth accounts (I don't make enough right now to max everything out, so I doubt I'd be getting anything from taxable accounts). These dividends are "cashed out" twice a year? How does this work for early retirement as far as early withdrawal penalties are concerned? Does taking the dividends ONLY count as early withdrawal?...

Most companies pay out dividends quarterly.  A few do it monthly.  If you want to make sure that cash is available to you, make sure your brokerage account is set up NOT to automatically reinvest those dividends.

You can "cash out" those dividends any time you want out of your tax-deferred and ROTH accounts.  Anything you take out of a ROTH would not be subject to any income tax (because you've already paid it).

There IS a way to avoid the early withdrawal penalty on IRA accounts by instituting a process of "substantially equal withdrawals" over a specified period of time, but you'll need to have a tax professional make sure you do it right. (Start off by going to the irs.gov website and search under "substantially equal withdrawals" and see what you learn.

Good luck.

bacchi

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Re: Living Off Interest in Early Retirement?
« Reply #7 on: February 15, 2015, 04:49:45 PM »
You can "cash out" those dividends any time you want out of your tax-deferred and ROTH accounts.  Anything you take out of a ROTH would not be subject to any income tax (because you've already paid it).

Addendum: Only the contributions are tax-free. Anything above and beyond what is contributed is taxed and penalized (without being 59.5).