Rule of 25 & Retirement

It can be difficult when planning for retirement to determine exactly how much money you actually need to have saved. The Rule of 25 offers a way to create a quick estimate and get a sense of how much you really need to put away.

The guiding principle of the rule is that, if you can save 25 times what you hope to live on each year in retirement, then that money will actually last 30 years. It’s not perfect and there are plenty of other factors to consider, but it can give you a snapshot of your savings situation.

It’s important to remember when using the 25x situation that it’s not a perfect solution or an exact dollar amount to strive toward. The rule doesn’t include Social Security or other forms of income, just your savings. It also assumes a normal retirement age and doesn’t make sense to use if you’re planning on retiring early.

The Rule of 25 is fairly simple to calculate. The first thing you need to determine is how much money you want to be able to spend annually in retirement. Once you have that figure, subtract Social Security from it, as well as money you are getting from a pension or any source other than your savings.

For example, you may want to live on $80,000 per year in retirement but have a pension plus Social Security what will cover $30,000 a year of that. Then the figure you are left with is $50,000.

Once you have your figure, multiply it by 25. The number that comes out is an estimation of how much you would need to have saved for your money to last 30 years after you retire. Using the $50,000 figure from the example, you would have to save $1,250,000.

You may have also heard of the 4% Rule. This goes hand in hand with the Rule of 25.

According to Forbes, the 4% Rule states that you could theoretically withdraw 4% of your retirement portfolio each year you are retired and not run out of money for 30 years.

This rule relates to the 25x Rule because they essentially equate to the same thing: figuring out how much money you must save for retirement in order for it to last 30 years.

Think about it this way: Let’s say that you saved exactly $1 million for retirement. According to the 40% Rule, you would be able to take out $40,000 annually and not run out of money for 30 years.

On the flipside, if you decided that you need $40,000 annually to get by and used the Rule of 25 to calculate how much you need to save, you would land on $1,000,000.

The Rule of 25 and the 4% Rule basically get you to the same place. You’re just looking at the figure from two ends of the equation. Each rule gets you to the same place as far as what you need to save to have a financially successful retirement.

If you’re using the Rule of 25, it’s important to remember that the rule has a number of drawbacks. It’s not a perfect equation, and using the figure you come up with as a specific goal instead of a ballpark or guiding principle could be dangerous.

As stated above, one key thing to remember is that Social Security benefits, pensions and forms of revenue are not included in the calculation, even though they will play a big role in how much you can save for retirement.

The biggest potential flaw in the rule is that it doesn’t factor in inflation in any way, even though that’s an obstacle you will likely have to deal with in retirement. Say that you decide you want to live on $75,000 annually when retired. That money will likely go a lot farther next year than it will in 20 years.

For example, you would need nearly $120,000 in 2022 to maintain the lifestyle that $75,000 would’ve bought in 2002.

Another potential drawback is the concern that rules like the 25x Rule and the 4% Rule may be growing outdated as Americans’ financial situations continue to change in the 21st century.

In fact, according to CNBC, some experts believe the 4% Rule needs to be rethought at the 3.3% Rule.

These rules can be a helpful way to get a sense of where your retirement saving is at, but probably shouldn’t be used to come up with a hard number to work toward.