One of the most common objections that people raise when discussing annuities is: "Why tie up my money in an annuity when I could just live off the interest of my portfolio?"
 

At first glance, this might seem like a reasonable approach. After all, who doesn’t want to live off the interest or dividends from their investments while preserving the original principal? It sounds like the ideal way to create a sustainable income stream without risking your life savings.
 

However, when you take a closer look at this strategy, there are several major flaws that retirees often overlook.

Let’s break down why trying to live on fixed interest alone might not be the best strategy for modern retirees — and why annuities can be a far more reliable, flexible, and income-enhancing alternative.


Here Are The Drawbacks of Trying To Live Off Interest-Only As Retirement Income:

 

1. You're a Slave to the Current Interest Rate Environment
 

One of the biggest issues with relying solely on interest income is that you are at the mercy of interest rates.

The rate of return on your portfolio is not guaranteed; it’s influenced by the broader economic environment, including the interest rate policies set by the Federal Reserve.
 

For the past decade or more, interest rates have been at historically low levels. During this time, many retirees have struggled to generate enough income to maintain their desired lifestyle. For example, in 2020, the national average for a 1-year CD was around 0.20%, which made living off interest income nearly impossible for most retirees unless they had an enormous principal.
 

Even now, while interest rates have risen somewhat, they still may not be high enough to provide meaningful income for retirees. At 5% interest, for instance, a retiree would need to tie up $1 million in low-risk investments (such as a CD or a bond portfolio) to generate just $50,000 a year — a figure that might not even be enough to cover basic living expenses, depending on the retiree’s lifestyle.
 

Moreover, interest rates can fluctuate. In the future, they could drop again, leaving retirees stuck with lower returns. If your entire strategy revolves around interest income, this unpredictability can become a serious problem.

 

2. No Compound Interest on Your Principal
 

Another major flaw in the “living off interest” approach is that you are not allowing your principal to grow.

With this strategy, 100% of the growth/income generated is being swept off the top for living expenses. This means that there’s no opportunity for your original capital to compound over time.
 

While you might receive interest payments, those payments are used up immediately, leaving the original principal to stagnate and actually shrink in annual purchasing power at whatever the current inflation rate may be.

In contrast, if you invested in a growth-oriented strategy (such as an annuity or a diversified portfolio that includes a mix of equities and fixed income), you could continue to grow your principal while also generating income.
 

For example, if you could generate $50,000 per year from a portfolio and leave $50,000 in principal to grow (instead of taking it all), you could achieve compound growth on that remaining balance. But when you’re tied to fixed interest, this kind of growth is off the table. As a result, you’re likely to find yourself with less money over time — and fewer options for dealing with unexpected expenses or inflation.

 

3. No Inflation Protection or Cushion for Emergencies
 

Inflation is a major concern for retirees. Even if you’re able to generate income from your interest, the purchasing power of that income will erode over time. For example, if you’re living on a $50,000 income generated by interest on your portfolio, and inflation increases by 3% per year, your income will lose purchasing power every year.
 

Let’s say you have a $1 million portfolio earning 5% annually, and you’re living off the interest to generate $50,000 in income. Now, let’s also assume that you face an unexpected emergency, such as a medical bill or a home repair, which costs $100,000.
 

If you use $100,000 of your portfolio to cover this expense, you now only have $900,000 invested at 5%, which will reduce your interest income. That means your income goes from $50,000 to $45,000, which could put a serious strain on your ability to maintain your standard of living. Now, your $900,000 is generating less income, and you’re no longer able to produce the level of income you originally relied upon.
 

This presents a huge risk: Once you’ve withdrawn funds for an emergency, you’re locked into a lower income stream for the rest of your retirement, with no cushion for future needs. You’ve also lost the ability to regenerate your principal, making it even harder to maintain your standard of living going forward.

 

4. Tying Up Way Too Much Principal for Only Mediocre Levels of Income In Return
 

Living off interest income can require you to tie up a significant portion of your portfolio just to produce modest returns. Let’s take a look at a hypothetical example to understand the magnitude of this issue in comparison to a comparable annuity solution:
 

Hypothetical Example: A 67-year-old retiree has $1 million in principal and decides to live off the interest generated by a 5% CD. This means they are producing $50,000 in annual income.
 

However, by using the same $1 million portfolio starting balance and placing only $700,000 in an annuity, they could generate around  $58,000 in guaranteed lifetime income (based on current annuity rates at the time of this writing) — a full 16% higher income — with just $700,000 tied up in the annuity. This means they’re using 30% less principal to generate 16% more income, and the remaining $300,000 can continue to grow, stay liquid, or be used for emergencies.
 

Additionally, that $700,000 annuity would provide guaranteed lifetime income that the retiree can never outlive. This provides much more financial security than the interest-based strategy, where the income could fluctuate and the principal could be at risk if the market underperforms or the retiree has to liquidate assets unexpectedly.
 

The real benefit here is that the retiree has much higher income than the interest-only approach, but also has much more flexibility and peace of mind knowing that their income is guaranteed and that they still have significant principal available for future needs.  Do the math on what that $300,000 would turn back into over 15 years at an 8% average stock market return; and that's on top of and in an addition to the $58,000 per year of lifetime income still coming in like clockwork 15 years+ down the road!  Which brings us to our final point...

 

5. Annuities Provide More Security, Predictability, and Long-Term Growth Potential (By Freeing Up Other Assets For Growth)
 

A major advantage of annuities over living off interest alone is the guaranteed income stream. Annuities are designed to provide you with a predictable income for as long as you live — regardless of how the market performs or what interest rates do. This is especially important for retirees who are concerned about outliving their savings.
 

Furthermore, because annuities often come with inflation protection features, they can adjust your payments over time to keep pace with inflation, unlike fixed interest strategies where income remains static and is eroded by rising costs.
 

Another benefit is that annuities allow you to dedicate far less principal to generate the income you need. This means that a significant portion of your portfolio can remain available for other needs — such as healthcare expenses, emergencies, or even legacy planning for your heirs.

With the the laddered annuity plans we build for clients, we are typically able produce 100% of a client's lifetime income requirement, using roughly half their portfolio to do it with (in the annuity ladder).  

We also like to leave at least 10% of the total portfolio in what we call the emergency cash position or (ECP), which ultimately leaves somewhere between 25-40% of the remaining total portfolio available to enjoy undisturbed compound growth all throughout retirement - without ever again having to shoulder the burden of income production - because the income is permanently solved for live via the laddered annuity strategy. 

 

Conclusion: Why Living Off Interest Alone is Becoming Obsolete
 

The strategy of living off interest income has been a popular method for retirees for decades, but in today’s low-interest-rate environment and with increasing inflation pressures, this approach is rapidly becoming obsolete. Not only does it tie up far too much principal for modest returns, but it also exposes retirees to risks like inflation, market volatility, and unexpected expenses.
 

In contrast, annuities offer a more reliable, predictable, and flexible way to generate stable income while freeing up principal for future growth, emergencies, or legacy planning. By shifting to a well-designed annuity strategy, retirees can enjoy guaranteed income for life, protect their principal, and have a much higher chance of financial security in retirement.
 

Ultimately, annuities offer a much more attractive and flexible solution to the limitations of the “living off interest” approach — and are a far more modern and secure way to plan for a financially stable retirement.

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