Could you live off term deposits?

While a high cash rate can mean pain for mortgage holders, it also usually means it’s a great time to be a saver. As the RBA have raised rates, returns on term deposits and savings accounts have swollen to the highest since 2015.

While your earning ceiling is probably higher if you invest in shares or the property market, the advantage of term deposits is they are largely risk free, with a guaranteed income. If you were to lock in a three-year term deposit in July 2023, the bank will honour those rates even if we see a dramatic drop to interest rates elsewhere in the coming months.

If you’re lucky enough to be flushed with cash, you might wonder whether interest rates are high enough for you to live off the income generated by a term deposit. We’ve broken down exactly how much Aussies stand to earn from term deposits at the moment, and whether this could be a legitimate avenue to the early retirement you’ve secretly always dreamed of.

What's the most you could earn from a term deposit in 2023?

Right now, term deposit rates are as high as they’ve been for a long time, and with further cash rate increases possible, it’s likely the coming months will see rates go up even more. For now, Judo Bank, a neobank established in 2016, offers the highest long term deposit rates. The maximum deposit size at Judo is only $999,999, though, so for the purposes of demonstrating the largest income someone could earn from term deposits, we’ll refer to AMP, which allows deposits of up to $5,000,000.

Once you’ve chosen a term length, you can then choose how often you want to receive interest payments. AMP allows payments at monthly, quarterly, semi annual or annual intervals, as well as a lump sum at the end of term. If you elect to receive payments at intervals, the interest you accumulate each period is deposited in a bank account you nominate. Most providers offer slightly reduced interest rates for this luxury. AMP reduces rates by 20 basis points for monthly payments, 10 for quarterly and 5 for semi annually.

Below are the following rates AMP offer for personal term deposit products, for deposits sized from $25,000 to $5,000,000 (correct as of 27/07/2023):

So, let's say you are looking for a monthly income from your term deposit. This is approximately how much income you could expect to earn from a $5,000,000 deposit.

If you’ve got $5,000,000 to spare, you could bring in a very respectable income right now from term deposits, which most Australians would have no trouble living off. Bear in mind also that interest is taxable income, so you would be taxed according to your tax bracket. For the 2023-2024 tax year, anyone with an income over $180,000 will be taxed $51,667 plus 45c for each $1 over $180,000.

For most of us, these rates aren’t super relevant. A 2021 Credit Suisse report found only 1.8 million Aussies - about 7% of the population - had a net worth that exceeds $1 million USD (about $1.47 million AUD). The average Australian's net worth, according to the ABS, is around $569,000.

Let's say this representative individual decides to liquidate everything they own, and put it all entirely into a term deposit to live off the interest. This is how much they could earn, this time using Judo, which offers some of the highest rates in Australia as per Savings.com.au’s market research. This time around we’ll also use the highest available rates, where interest is paid annually, to maximise earnings (we’ll subtract $44,000 from the deposit for living expenses).

So the average Aussie could earn an annual income of less than $30,000 if they put everything into term deposits. This is just about above the poverty line, as defined by the OECD ($489 per week income for a single adult). If you’ve managed to accumulate more than half a million dollars worth of wealth, this likely isn’t a very exciting prospect.

It is worth pointing out again that you would be doing nothing for this money. In theory, you could use your interest income for your living expenses, then spend the rest of your time on other endeavours, starting a business perhaps, that might earn you income down the track. This would be a bit of a gamble however, especially when you consider liquidating assets means selling the house for most Aussies. You should also consider the break penalties, which we’ll discuss in more detail shortly.

Realistically, for living off term deposits to be viable, you probably need to be among the top percentile net worth individuals in Australia.

What happens if you break a term deposit early?

One major concern about living off term deposit income is what happens in case of emergency, if you need to access your funds before the term finishes.

The terms and conditions in these instances vary from bank to bank. There is usually a minimum notice period, and often penalty rates, where a proportion of the interest you’ve accumulated is withheld.

Judo, for example, have the following ‘prepayment adjustment’ rates, which is the proportion of your interest withheld.

For example, let's say you have a $100,000 term deposit invested for one year at 5.45% p.a. You go to withdraw it after 100 days, after giving the appropriate notice.

Your accrued interest is $100,000 * 5.45%p.a /365 * 100 = $1,493.15

Prepayment adjustment is $1,493.15 * 80% = $1,194.52, which is deducted from the principal plus interest accrued. You would therefore only end up with $298.63 total interest.

This is a further constraint on the ability to live off term deposit returns. Penalty rates, particularly those incurred near the beginning of a term deposit, can be severe. In the above example, locking away $100,000 for more than three months resulted in a grand total of less than $300 in interest.

Savings.com.au’s two cents

Unless you’re a verified one percenter, living off term deposits probably isn’t a super viable option, but that doesn’t mean you should ignore them entirely though. While returns on TDs tend to be lower than riskier investments, it can be a guaranteed way to grow your money.

For self managed super funds, for example, term deposits can be a great means to slowly grow wealth over time, without risking it. Some lenders have specific term deposit products for SMSF customers. At Judo for example, SMSF products have similar rates to personal term deposits, with slightly lower rates for longer terms. Over time, you could reinvest the interest you accumulate back into term deposits, compounding it.

Your investment is also backed by the Financial Claims Scheme (FCS) up to $250,000, meaning even in the (extremely unlikely) event your bank goes bust, the government will make you whole.

Want to earn a fixed interest rate on your cash? The table below features term deposits with some of the highest interest rates on the market for a six-month term.

Picture by Morgan Housel on Unsplash