How To Use The 25x Rule For Smart Retirement Planning

What is the 25x Rule for Retirement?

The 25x rule for retirement is a general guideline that uses a simple calculation to help you approximate how much personal retirement savings you’ll need. It works by taking the estimated annual retirement income you expect to draw from your savings, and then multiplying that number by 25.

With this ballpark figure, you’ll get a general idea of your retirement needs so you can start planning accordingly, and improve your chances of achieving a successful retirement.

When it comes to planning for retirement, it helps to have guidelines to follow. Even if you’re not a rule-follower, it’s important to consider how any rule that claims to strengthen your financial security would fit with your situation.

In this post, you’ll learn how to implement the 25x rule in your retirement savings strategy. You’ll also find out why it works, so you can determine for yourself if this rule fits your unique situation.

First, let me explain how you can apply the 25x rule to your own retirement saving strategy.

How do I use the 25x rule for retirement?

The 25x rule will give you a high-level view of your financial needs once you retire. This strategy simply takes your estimated annual retirement income needs, and multiplies that amount by 25. The result is your target retirement savings.

Let’s break that down with an example:

1. Your current income is $80,000. You create a retirement budget that includes all of the anticipated annual expenses during retirement, and decide that your retirement income needs will be roughly $70,000 a year.
2. Once you determine your annual retirement income, be sure to subtract any other sources of retirement income you expect to receive outside of your savings. This would include Social Security, pensions, inheritances, passive income, etc. For this example, let’s assume that these additional sources will cover 30%, or $21,000 of your expected annual income. This means you would need to cover $49,000 a year with savings.
3. Multiply $49,000 times 25, which equals $1,225,000. This is your retirement savings goal.
4. Based on how many years you have left in the workforce, you determine a savings strategy that will get you close to this baseline retirement goal.

Why does the 25x rule work?

In retirement planning, there is a general rule of thumb to save 25 times your estimated retirement annual expenses. This comes with the expectation that you will maintain a consistent withdrawal rate over a 30-year period.

By applying the 25x rule to your own financial circumstances, you’ll get an estimated total amount of savings that should last approximately 30 years.

So, if you can withdraw less, your savings will last longer. If you begin to go over your retirement budget, you’ll run out faster.

You might be wondering who came up with the number 25, and that’s a good question. Let’s go over that next …

Is the 25x rule the same as the 4% rule?

A financial advisor named William Bengen conducted a study in 1994, which revealed that a person could withdraw 4% of their retirement portfolio over 30 years and not run out of money. This has become known as the 4% rule.

So, what does 4% have to do with 25? Let’s do some math.

If you multiply 4% of any value by 25, you will get 100% of the value.

Taking the example from the previous section, you’ll see that 4% of $1,750,000 equals $70,000. Then, if you multiply $70,000 by 25, you’ll get right back to $1,750,000.

So, while the 4% rule represents your annual withdrawal rate and income in retirement, the 25x rule gives you the *total* estimated amount of savings you’ll need.

Assumptions and limitations of the 25x rule of thumb

The 25x rule is based on future estimates to give you a general idea what your retirement needs will be. In other words, it is not a precise strategy.

In order to work, the 25x rule has to make certain assumptions, which may or may not apply to your circumstances. Therefore, it’s important to consider these factors before implementing this financial rule into your savings strategy.

• It does not factor in Social Security, pensions, or any passive, earned or extra income outside of savings.
• It assumes a 7% annual rate of return on stock investments.
• It only provides an estimate of how much you need at retirement, and not the withdrawal rate.
• It does not include inflation, so you’ll need to factor that into your income needs.
• It assumes a normal retirement period of 30 years (not FIRE).
• This rule was created in 1994, and many consider it outdated. Especially with the effects of the COVID-19 pandemic still unfolding, most Americans’s financial circumstances have changed drastically.

Does the 25x rule really work?

As stated previously, the 25x rule is a general guideline that can act as a starting point to your baseline retirement goals.

The more accurate you can get with your estimated retirement income needs, the more reliable this rule will be in your savings strategy. Because it cannot predict or consider future unknowns, it’s important to include various scenarios in your retirement planning.

For example, your healthcare costs will likely increase as you get older, while recreational expenses will decline over time. Be sure to include these financial changes when you estimate your annual retirement income goal.

Should I use the 25x rule in my savings strategy?

If you are doing your own retirement planning (without the help of a financial advisor), then the 25x rule can be helpful in determining your income needs.

Thinking about saving enough to last for a 30-year time span can seem daunting, but the 25x rule can provide a realistic starting point. This quick estimate can give you a direction to work towards, and a general sense of how much you’ll need before you retire.

Of course, nobody could ever predict the exact size your nest egg needs to be, or your life expectancy. But, even though it’s not a perfect and complete solution to your retirement planning, you’ll at least get a target goal for how much you’ll need to save.

How to determine your annual retirement income needs

In order to apply the 25x rule to your savings strategy, you’ll need to have a good idea of what your income needs will be for the kind of retirement life you desire. The best way to calculate this is to create a retirement spending plan that includes your estimated future expenses and income.

Your annual expenses in retirement will depend on the lifestyle you want once you retire. Here are a few questions to ask yourself:

• Will I move locations, downsize, or stay in my current home?
• Will I have a mortgage balance?
• What will my healthcare insurance needs be?
• Will I be debt-free?
• How do I want to spend my time? (Travel, hobbies, volunteer, etc.)

It’s a good idea to talk to your partner or spouse to determine the lifestyle you want to achieve in retirement. These retirement goals will guide your saving efforts, and give you a baseline of how much income you’ll need every year.

Once you have some numbers, create a retirement spending plan based on the financial changes you anticipate, and your current annual spending.

Don’t forget to include all income sources in your budget. Your retirement fund should only be one of several income streams, so your savings is not your only financial supply. 

Also, keep in mind that most financial experts will suggest that your income needs for your retirement life will decrease. If your mortgage is paid off, you’re debt-free, and your kids are done with college, then you will only need 60% to 80% of your pre-retirement income.

This is good news for the late saver! Once you include social security and other income sources, as well as consider your reduced income needs, then you’ll see that your savings goals are much more achievable.

FAQs

In summary

The 25x rule for retirement can be a good starting point for retirement planning. Because it is considered a “rule of thumb”, you shouldn’t consider it as an exact strategy. 

• The 25x rule uses a simple calculation to help you approximate how much retirement savings you’ll need.
• This strategy multiplies your estimated annual retirement income needs by 25, which results in your target savings goal.
• It is a tool that complements the 4% rule, which states that if you maintain a 4% withdrawal rate over a 30-year time period, you shouldn’t run out of savings.
• The 25x rule works under several assumptions. It doesn’t consider any sources of income outside of your savings, it assumes 7% for investment returns over a 30-year retirement, and does not include the current rate of inflation into its calculation.

Although the 25x rule is not a perfect solution to your financial planning, it is a helpful tool to use for a traditional retirement plan. It gives you a savings goal to work toward, based on your estimated retirement budget.

Even if you decide that the 25x rule is not the best fit for you, it’s helpful to know how it works, and its limitations will help you come to an educated decision.

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I hope you enjoyed reading

How To Use The 25x Rule For Smart Retirement Planning