The rule of 25 for retirement: What it means and how to calculate it

One of the biggest challenges of retirement planning is figuring out how much money you need. There are several ways to estimate it , including talking to a financial advisor or using a retirement calculator.

But if you’re looking for a quick and simple calculation, a guideline to aim for, then consider the rule of 25.

What is the rule of 25 for retirement?

The rule of 25 is simple: You should have 25 times the annual amount you plan to spend in retirement saved before you leave the workforce.

“Essentially, it can help point you in the right direction so you can begin making meaningful changes in your current retirement plan,” says Cody Lachner, a certified financial planner and founder of Next Adventure Financial.

Because it’s so simple, the 25x rule makes a few assumptions while neglecting a few important details. First, the rule assumes a 30-year retirement and a 4% withdrawal rate each year during retirement. It also assumes that your retirement savings are invested, perhaps in a Roth 401(k) or Roth IRA, so your money continues to grow.

One thing the rule of 25 doesn’t consider isother sources of retirement income, such as Social Security, pension benefits or a part-time job. So the principle is far from an exact science since it only considers how much money you need to accumulate in your investment accounts prior to retirement.

“And it isn’t helpful when you’re planning for ‘lumpy’ spending patterns in retirement; i.e. you intend to travel extensively the first decade of retirement and then reduce your spending later in life,” says Lachner.

People who are pursuing FIRE (financial independence / retire early) often adopt a more ambitious rule of 30 to 40, since their retirement nest egg needs to stretch longer than the average person’s. And since they will likely need the money long before age 59 ½, they may not have the luxury of using tax-advantaged accounts to grow their wealth.

How the rule of 25 works

Here are the basic steps to calculating how much you need for retirement using the rule of 25:

1. Figure retirement spending

2. Subtract your estimated Social Security benefits

3. Apply the Rule of 25 to the remainder

First, you’ll need to calculate your estimated retirement income. Many experts recommend 80 percent of your current expenses since some costs — like a monthly mortgage payment or commuting costs — might not follow you into retirement. But it really depends on the lifestyle you envision for yourself.

If you still have a mortgage (or rent), plan to travel extensively, want to pick up an expensive hobby or help financially support someone, your retirement spending might be similar to your current spending. For this example, we’ll imagine your estimated retirement spending is $40,000 a year.

Next, the rule of 25 doesn’t account for sources of retirement income outside your investment accounts, such as a part-time job or Social Security benefits, so you’ll want to factor those in. (Here’s what the average Social Security check is for reference.)

Let’s say you plan to collect $20,000 in Social Security benefits each year. Subtract that from your annual retirement expenses (40,000 – 20,0000 = $20,000).

Finally, apply the rule of 25. So, if you expect to spend $40,000 in retirement each year and receive $20,000 in other sources of income, you would need $500,000 by the time you leave the workforce ($20,000 x 25 = $500,000).

The rule of 25 vs. 4% rule

The rule of 25 is just a different way to look at another popular retirement rule, the 4% rule. It flips the equation (100/4% = 25) to emphasize a different part of the retirement planning process — withdrawing vs. saving.

The 4% rule outlines a safe rate to withdraw funds for 30 years without running out of money. On the other hand, the rule of 25 is a savings-focused approach, providing a quick estimate of how much you need to accumulate before exiting the workforce.

Let’s consider a scenario to highlight the difference:

• Rule of 25: After accounting for her Social Security and other sources of retirement income, Katie plans to spend $40,000 a year in retirement. 40,000 x 25 = $1 million, so Katie would need $1 million invested to cover annual expenses of $40,000.

• The 4% rule: Katie, now a retiree, has $1 million in retirement savings and follows the 4% rule. She can safely withdraw $40,000 annually (4% of $1 million).

While the 4% rule helps plan withdrawals during retirement, the rule of 25 helps establish a savings goal before retirement begins.

Pros and cons of the rule of 25

Like any guideline, the 25x retirement rule has its pros and cons.

Pros

• Simple: The rule of 25 is straightforward and easy to understand, making it an accessible starting point for retirement planning.

• Quick: You don’t need to tweak an online calculator or schedule an appointment with a financial advisor to get a rough idea of how much to save for retirement. After mapping out your retirement expenses, you can calculate your number in less than a minute.

Cons

• Assumptions: The rule relies on the assumption that a 4% withdrawal rate will sustain a retiree’s lifestyle for 30 years. But your situation might be totally different, and factors like market conditions, inflation, health care costs and other unexpected expenses erode the rule’s accuracy.

• Oversimplification: While simplicity is an advantage, oversimplifying complex financial planning can be a drawback, too. A birds-eye-view won’t provide all the detail you need to plan for a secure future.

Bottom line

The rule of 25 is a simple guideline used in retirement planning. While it serves as a good starting point, you’ll want to zoom in and refine your retirement strategy over time to get a more accurate picture of your savings goal. Bankrate’s AdvisorMatch can connect you with a certified financial planner in minutes if you’re seeking a more personalized approach.