The 25x Rule for Retirement: Your Secret Formula for Financial Freedom

Have you ever wondered exactly how much money you need to save for retirement? It’s one of those nagging questions that keeps many of us up at night. I remember staring at my bank account a few years ago thinking, “Am I even close to where I should be?” That’s when I discovered the 25x rule – a simple but powerful guideline that changed my entire approach to retirement planning.

What Is the 25x Rule?

The 25x rule is a straightforward calculation that suggests you should save 25 times your expected annual retirement expenses before leaving the workforce. It’s designed to give you a quick estimate of the total nest egg you’ll need to retire comfortably and maintain your lifestyle without running out of money.

For example, if you expect to spend $40,000 annually in retirement, following the 25x rule means you’d need approximately $1 million saved up ($40,000 × 25 = $1,000,000) before you can confidently retire

The Origins of the 25x Rule

The 25x rule didn’t just appear out of nowhere. It’s actually closely related to another popular retirement guideline – the 4% rule, which was established by financial planner William Bengen in 1994. Bengen analyzed historical market data and determined that retirees could withdraw 4% of their portfolio in the first year of retirement and then adjust that amount for inflation each year thereafter, with their savings likely lasting at least 30 years

The connection? Well the 25x rule is essentially the flip side of the 4% rule

25x Rule = 100 ÷ 4% = 25

So if you save 25 times your annual expenses, you can safely withdraw 4% each year without depleting your portfolio too quickly.

How to Calculate Your 25x Retirement Number

Figuring out your personal 25x target isn’t complicated, but it does require some thought about your future lifestyle. Here’s a step-by-step process:

1. Estimate your annual retirement expenses

   • Many experts suggest using 80% of your current expenses as a starting point
   • Remember to account for healthcare costs, travel plans, hobbies, etc.

2. Subtract other income sources

   • Social Security benefits
   • Pension payments
   • Part-time work income
   • Rental property income

3. Apply the 25x multiplier to the remainder

Let’s work through an example:

Take the example of someone who makes $70,000 a year and thinks they will need about $56,000 a year in retirement, which is 80% of their current income. The amount of money you expect to get from Social Security each year is about $20,000.

$56,000 – $20,000 = $36,000 (amount needed from your investments)
$36,000 × 25 = $900,000 (your 25x retirement savings target)

In this scenario, you’d need to accumulate $900,000 in retirement savings to fund your lifestyle without running out of money.

Advantages of the 25x Rule

The 25x rule has gained popularity for several good reasons:

• Simplicity: It’s incredibly easy to understand and calculate without complex formulas or financial advisors.
• Quick starting point: It gives you a tangible number to aim for rather than a vague “save as much as possible” approach.
• Motivation: Having a specific target can be psychologically motivating, helping you adjust your budget and spending to better align with your retirement goals.
• Conservative approach: The rule is generally considered a safe guideline that accounts for market fluctuations and inflation.

As Stuart Schiffman, founder of Compound Wealth Advisors, explains, “The 25x rule is meant to be one of those back-of-the-envelope calculations that can be helpful but not ideal for personal financial planning.”

Limitations of the 25x Rule

While the 25x rule provides a useful baseline, it’s definitely not without its limitations:

• One-size-fits-all approach: The rule doesn’t account for individual circumstances like health conditions or family situations.
• Retirement length assumptions: It’s based on a traditional 30-year retirement, which might not be accurate for early retirees or those with exceptional longevity.
• Market conditions: The rule doesn’t adjust for different market environments or P/E ratios, which can significantly impact safe withdrawal rates.
• Simplified investment returns: It assumes your investments will generate sufficient returns without specifying the exact asset allocation needed.

As Constance C. Amstutz from JFS Wealth Advisors points out, “Lifestyles can change and evolve over time.” Those in early retirement may travel more while they’re healthier but slow their pace as they age, which could decrease expenses over time.

The 25x Rule vs. The 4% Rule

Though these two retirement guidelines are closely related, they approach retirement planning from different angles:

Let’s see this distinction in action:

25x Rule Example: After accounting for Social Security, Katie plans to spend $40,000 yearly from her savings in retirement. Using the 25x rule, she calculates that she needs $1 million saved (40,000 × 25 = $1,000,000).

Example of Rule 4: Katie has saved up her $1 million nest egg since she retired. Because she is following the 4% rule, she can safely take out $40,000 in her first year of retirement, which is 4% of $1,000,000

Adjusting the 25x Rule for Different Scenarios

The standard 25x calculation might not be right for everyone. Depending on your circumstances, you might need to modify the multiplier:

For Early Retirees (FIRE Movement)

If you’re planning to retire significantly earlier than the traditional age, your savings need to last longer. Many FIRE (Financial Independence, Retire Early) enthusiasts adopt a more conservative approach:

• 30x Rule: For those planning a 40-year retirement
• 33x Rule: For those concerned about market volatility or planning an especially long retirement
• 40x Rule: For extremely early retirees (in their 30s or 40s)

Research has shown that to withstand a 50-year retirement, you might need to rely on an initial withdrawal rate of no more than about 3.5%, which translates to saving about 29 times your annual expenses.

For Conservative Investors

If your investment portfolio is more conservative than average, you may need to save more to compensate for potentially lower returns. A more conservative withdrawal rate of 3% would require a 33x multiplier:

100 ÷ 3% = 33.3

For Aggressive Investors

On the other hand, if you want to be more aggressive with your investments and are okay with higher withdrawal rates, you could use a 2020x multiplier (based on a 5% withdrawal rate):

100 ÷ 5% = 20

Real-World Application of the 25x Rule

I’ve been using the 25x rule as part of my own retirement planning for the past few years, and it’s been super helpful. When I first calculated my number, it was honestly a bit scary – I needed to save about $1.2 million based on my desired lifestyle! But having that concrete target helped me make better financial decisions.

For example, I found that I was spending too much on subscription services and eating out. I’ve been able to speed up my progress by cutting back on these things and putting more money into my 401(k). The 25x rule made what seemed like an impossible goal into a series of steps that could be reached.

Asset Allocation and the 25x Rule

The 25x rule doesn’t specify how your retirement savings should be invested, but your asset allocation plays a crucial role in making this strategy work. Studies have shown that different portfolio compositions can produce higher safe withdrawal rates than others.

In William Bengen’s original research, he assumed a portfolio of large-cap domestic stocks and intermediate-term Treasuries. Later research found that adding small-cap stocks to the mix could increase the safe withdrawal rate from about 4.1% to 4.25%.

A reasonable starting point for many retirees might be the traditional 60/40 portfolio (60% stocks, 40% bonds), though some financial experts suggest this may be too conservative for certain investors.

Common Mistakes When Using the 25x Rule

When applying the 25x rule to your retirement planning, watch out for these common pitfalls:

1. Forgetting about inflation: Your expenses will likely increase over time due to inflation.
2. Ignoring taxes: Different retirement accounts have different tax implications that could affect your withdrawal strategy.
3. Underestimating healthcare costs: Medical expenses often increase significantly in retirement.
4. Not adjusting for lifestyle changes: Your spending patterns will likely change throughout retirement.
5. Using gross income instead of expenses: The rule should be applied to your expected expenses, not your current income.

Alternatives to the 25x Rule

While the 25x rule provides a useful baseline, some financial planners recommend alternative approaches:

• Dynamic withdrawal strategies: Adjusting your withdrawal rate based on market performance and portfolio value.
• Bucket strategies: Dividing your retirement savings into different “buckets” with varying investment strategies based on when you’ll need the money.
• Guaranteed income approaches: Utilizing annuities or other products that provide guaranteed lifetime income.

As Bobbi Rebell, a certified financial planner, suggests, “Instead of a one-size-fits-all, sometimes a personalized strategy is a good approach even if it is more complicated.”

The 25x rule gives us a straightforward target for retirement savings, making it easier to visualize our goals and track our progress. While it’s not perfect and doesn’t account for every possible retirement scenario, it serves as an excellent starting point for your planning.

Remember, the best retirement strategy is one you’ll actually follow through with. For many of us, the simplicity of the 25x rule makes it more likely we’ll stick with our savings plan.

I’ve found that combining the 25x rule with regular check-ins with a financial advisor provides the right balance of simplicity and personalization. Your retirement journey is unique, and the tools you use should adapt to your changing circumstances.

Disclaimer: This article is for informational purposes only and should not be considered financial advice. Consult with a qualified financial professional before making significant changes to your retirement strategy.