Is the 25x Retirement Rule still valid in 2024?

Retirement planning can seem complicated, with many guidelines and calculations claiming to have the answers for how much savings you need to live comfortably. One popular rule of thumb is the “25x retirement rule,” which states you should aim to have 25 times your expected annual spending in retirement savings. This simple formula has caught on due to its underlying basis in long-term market returns and safe withdrawal rates. However, as with any one-size-fits-all target, the 25x rule makes assumptions that may not suit your situation.

Understanding the rationale while also knowing its limitations is critical to planning appropriately. This blog will explain the 25x rule, discuss its shortcomings in today’s environment, and suggest modifications to make it more tailored to your needs. Whether just starting to plan or years into saving, the 25x rule provides a helpful benchmark to assess if you’re on track or need to make adjustments.

Understanding the 25x Retirement Rule

The 25x retirement rule guideline has been around for over two decades, with its conceptual roots tied to the Trinity study in the 1990s. Conducted by two professors, it analyzed market returns over extended historical periods to determine that 4% could be withdrawn each year from a retirement portfolio without running out over a 30-year timeline. This initial analysis gave rise to the simple shorthand that 25 times your needed annual income in retirement savings should reasonably support those withdrawals for 25 to 30 years of retirement.

In its most basic form, you multiply your expected annual spending by 25 to calculate a goal amount for retirement savings. For example, if you estimate needing $50,000 per year in retirement income, 25 x $50,000 = $1,250,000 total savings target. The more you plan to spend annually, the higher the savings needed to generate that income at a 4% withdrawal rate over a 30-year retirement.

Key Assumptions

Of course, all financial rules of thumb rely on assumptions. The 25x guideline assumes first that retirement will last 25-30 years, given improving lifespans. Second is that the 4% safe withdrawal rate will maintain purchasing power over time if adjusted for inflation annually. This means someone with $1 million saved could take out $40,000 the first year, then approximately $41,200 the following year if a 3% annual inflation adjustment is made. It presumes that over decades, the portfolio can still tolerate this 4% distribution rate without being depleted.

While the 25x rule offers a simple starting point for retirement savings, its limitations, like outdated assumptions and focusing solely on US stocks, warrant adjustments and considering alternative withdrawal strategies for a more personalized plan.

How Much You Should Have Saved

Doing the Math

So, how do you put this 25x rule into practice for your target savings needs? The first step is to estimate your annual spending in retirement. This entails looking at your living expenses and guessing how they might change without working. For example, certain costs like commuting and lunches out may decrease, while travel and healthcare expenses likely increase. Other spending like housing, food, and regular bills may stay comparable and adjusted for inflation.

As a baseline, you can assume that you need around 80% of your current after-tax income to maintain a similar standard of living. This figure gets adjusted as you input your own variable spending sources. Once you have that annual spending estimate, simply multiply it by 25.

For illustration, let’s look at some scenarios. Say you currently earn $100,000 per year, and after analyzing your budget, estimate needing $70,000 annually in retirement living expenses based on your lifestyle and geographic area. In this case, 70,000 x 25 = $1,750,000 as your target retirement savings. In contrast, someone used to living on $50,000 currently may only require $40,000 in yearly retirement spending. That becomes $40,000 x 25 = $1 million saved to sustain it utilizing the 4% rule.

The Bigger the Better

Having over 25 times your needed retirement income provides an extra cushion for unplanned expenses or lower market returns in any given period. If you are saving significantly more than the 25x benchmark for your lifestyle, additional analysis should be done to structure withdrawals for increased tax efficiency. Excess savings above what is estimated to support your spending could be tapped for higher distributions earlier on when typically in a lower tax bracket. This helps reduce required minimum distributions later that might push you into higher brackets at 70 1⁄2 years of age.

Is the 25x Rule Still Relevant in 2024?

The Case For 25x Retirement Rule

The 25x rule endures because it’s simple to use as an approximate benchmark, synthesizing assumptions grounded in actual market return data. Over 30 years historically, having 25 years worth of income-needing withdrawals has allowed portfolios following a 4% distribution strategy to endure ups and downs. Ensuring people don’t outspend portfolio longevity makes 25x a relevant and cautious guideline for many.

Another supporting reason is that today’s low-interest rate environment offsets some outdated assumptions around fixed-income returns baked into the old models. Having more conservative return projections now makes the 25x rule align more closely to how portfolios can realistically safely sustain the needed spending.

The Case Against 25x Retirement Rule

Critics of continuing to rely on 25x correctly point out that longer retirements exceeding 30 years are more common now, and expectations for market returns have shifted in the aftermath of the past 20 years. With more persistent low-interest rates and lower bond yields expected, portfolios overall can’t achieve the same returns. Consequently, distribution rates deemed historically safe require downward adjustments.

Some experts propose that with updated projections, even 4% inflated withdrawals may be too high to guarantee against shortfalls. This is especially true for very long retirements or Frontloaded withdrawals. Sophisticated analytical approaches incorporate sensitivity analysis across variable market sequences. In short, while still functional, 25x alone oversimplifies scenarios today’s retirees are likely to face.

25x Retirement Rule Variations to Consider

Ratio Adjustments

Many financial planning experts recommend a 25x multiple as reasonable for cautious savers. However, more conservative households may aim for a 30x benchmark, allowing just under a 3% withdrawal rate. This provides more buffer but requires significantly higher savings totals that may not be feasible.

Conversely, some research supports that multiples below 25x could adequately fund typical 30-year retirements. This is because sequential return risk declines over long periods. With today’s lower return assumptions, ratios between 20-22x are reasonable for risk-tolerant households. The most popular alternative rule suggests precisely having at least 20x your final working year income.

Dynamic Strategies

Variable withdrawal strategies can complement target ratios like 25x, allowing retirees to course correct based on portfolio growth year to year rather than sticking rigidly to fixed 4% distributions. This flexibility and incorporation of insured income sources like annuities recognize the uncertainty retirements lasting beyond 30 years face in the current environment.

Software tools now incorporate these dynamics to model sustainable spending rates at multiple comparative ratios. This allows households to dial their preferred assumptions, investment allocations, and longevity outlooks for a tailored plan vs. a one-size-fits-all 25x rule.

Final thoughts about the 25x Retirement Rule

For all its simplicity and longevity, applying the 25x rule in retirement planning still takes evaluation against your situation. Base spending needs, tax considerations, longevity outlook, and risk tolerance should factor into your target savings and withdrawal approach. As a starting point for a hypothetical 30-year timeline, accumulating 25x of your projected annual costs makes the best initial benchmark to assess.

Closer to retirement, adjust and stress test your plan frequently as updated data emerges. While still functional, exclusively relying on a 25x retirement savings rule of thumb is less appropriate, given shifts in markets, returns, and expanding longevity. Blending it with a dynamic withdrawal strategy spanning unpredictable sequences is critical.

Above all, avoiding under-saving remains critical, even if it means using ratios higher than 25x to account for unknowns. Having upside potential with more savings is preferable to spending unthinkingly and risking financial shortfalls. With flexibility and vigilance, this longtime centerpiece target ratio still provides practical guidance when determining retirement savings adequacy.

Disclaimers: The information is for general purposes only and not financial advice. The 80% rule of thumb is just an estimate, and individual spending needs can vary significantly, which would be helpful. Alternative withdrawal strategies beyond the 4% rule, like the bucket approach and variable spending based on market conditions, can also be explored.