As a young teenager, all you can think about is moving out of your parent’s house. Then as you hit your early twenties, it turns to finding a spouse and maybe starting a family. Then by the time you hit 30, your focus turns on your career and how you can make as much money as possible. Last, but certainly not least, your attention starts to turn to retirement.

Retirement is the next big step of freedom, however, that freedom certainly doesn’t come free.

To truly enjoy retirement, it takes years/decades of planning and contributing to making sure you have enough money to survive. It sounds crazy, but your retirement planning starts on the first day of work.

This brings me to the rule of 25.

What exactly is the rule of 25, you might ask? The rule of 25 is a strategy to help you estimate the amount of money you need to have saved to be able to retire with enough money to last you the rest of your life.

To calculate your own rule of 25, you would just take the amount of money per year you expect to spend in retirement and multiply it by 25.

An easy example would be that you expect to spend $60,000 per year once retired. That means your rule of 25 would be $1.5 million in your retirement accounts. That is a very simple explanation and there are a ton of other items to think about when planning for retirement. Keep reading for more things to think about when using the rule of 25.

• Calculating your target income
• Using the 4% rule with the rule of 25
• Other factors to consider when using the rule of 25
• What the rule of 25 doesn’t account for

Calculating your target income:

When it comes to retirement, perhaps the most important piece is calculating what monthly income you need to survive in retirement. Sure, the rule of 25 tells you the formula to get a great ballpark figure you’ll need to comfortably retire, but you still need to solve for the variable.

As with anything, a budget will be the key.

It’s extremely hard to prepare for this in your twenties or thirties, but you’ll certainly need to try. A few questions to ask:

• Will my house be paid off?
• Will I want a second retirement home?
• How long do I expect to live?
• How extravagant of a lifestyle do I want to live?

For me, I know I’ll likely want to purchase a home somewhere warm once I retire. I don’t expect to have any debt, I should live a normal life span of 90 to 95 years, and I don’t plan on doing any crazy traveling or spending once I retire.

I’ll be a fairly simple case, where standard living expenses, a small mortgage for a retirement home, and medical expenses should be plenty for me.

Don’t be ashamed if you know that you’ll want to spend more in retirement. There is nothing wrong with that, it just means you’re going to need to save more now.

My one piece of advice is to try and over-save slightly.

I know the saying goes “you can’t take your money with you,” but you also can’t always make more money when you’re 90 years old if you run out.

I would figure out what you think you want to spend in a month, and then just add 10 percent. It doesn’t need to be perfect now, you can certainly make adjustments as you go, but you need to make sure you have a baseline for retirement as early as possible.

Using the 4% rule with the rule of 25:

Man, there are an awful lot of rules when it comes to planning for your retirement. Both the rule of 25 and 4% rule are great rules of thumb to measure the amount of money you need to comfortably retire.

What is the 4% rule?

William Bengen, a certified financial planner, came up with this method. It entails never withdrawing more than 4% of your total portfolio in a year, to make the money last over a 30-year retirement period.

This rule was created using historical market and inflation data, but keep in mind, this is not a science. The data from this research was from the early 1990s, and the markets and inflation can certainly change over 20+ years time.

The rule of 25 was derived from the 4% rule.

If you multiply 4% by 25 (years), you’ll come up with 100% of the value (retirement account balance).

This rule is based on your initial withdrawal rate, but remember, this number can change. 4% is the standard number, but it is easily adjustable. For example, if you have fears of inflation, want to retire early, or know your investment portfolio is low risk with a lower rate of return.

Example – Say you want to withdraw $60,000 per year, but only feel comfortable withdrawing 3% of your total portfolio. This now becomes the rule of 33. You will need to have saved $2 million to have $60,000 of income available in the first year vs. the $1.5 million in my original breakdown.

You can also use this rule the exact opposite way as well.

Let’s say you believe your investments are going to outperform the market, or you know that you will have some additional income in retirement. You can use the 5% rule or withdraw up to 5% of your total portfolio.

That means if you want $60,000 of income in year one, you only need to have $1.2 million in retirement.

You would then be using the rule of 20 (5% multiplied by 20-years equals 100%).

The bottom line: the 4% rule paired with the rule of 25 is a fantastic strategy for retirement planning. The earlier you start, the better.

However, just like anything, it can’t be used as an exact science. There are a ton of different factors to account for when planning your retirement, and you must be cognizant of them all.

Other factors to consider when using the rule of 25:

As mentioned above, the rule of 25 is a great strategy to use, but there are other factors that you must consider.

Retirement Age – remember, the rule of 25 is based on a 30-year retirement life. 90 to 95 is the typical lifespan you want to account for, but if you are planning on retiring before the age of 60-65 you want to consider a different strategy.

If you are thinking of early retirement (age 55 or below), you need to consider a different rule to use.

It will be important to have supplemental income on top of retirement, especially in the early years. Taking retirement money early usually comes with penalties and extra taxes.

Remember – you can’t withdraw from your 401K until age 59.5 without an early withdrawal penalty of 10%. That means you would be going multiple years without wanting to touch that money. There is a provision that allows you to take from your 401K at age 55 without a penalty, but only from your current employer.

Example – You work at company X for 25 years and then leave for Company Y in 2010. In 2015, you are 56 years old and want to retire. You could take your retirement from Company Y at no penalty, but you would not be able to touch the accounts from company X until age 59.5.

Supplemental Income – another item the rule of 25 doesn’t account for is supplemental income on top of retirement. That could include a pension, separate trading account, retirement job, rental property incomes, or social security.

That means that any amount of money that you plan to have on a monthly basis can be reduced from your yearly income goal.

Remember, a side hustle can not only help you during your working career but can be beneficial in retirement as well.

Example – say you have two rental properties, a company pension, and will receive social security (at age 67) and it will total $30,000 a year of payments. If you want a yearly income of $60,000, you now only need to worry about having $750,000 in your retirement vs. $1.25 million.

For younger folks reading this and planning your retirement future, please don’t plan on getting social security payments. This is my opinion only, but it doesn’t look like a system that is going to survive another 20-30 years because of funding.

What the rule of 25 doesn’t account for:

The rule of 25 and 4% rule are great strategies for retirement, but there are a lot of factors that aren’t accounted for. Some items you can’t always predict.

Market fluctuations and inflation – It is always a great time to think about inflation and market corrections.

It’s something you must consider before finalizing a retirement date.

A small correction came in March/April of 2020 when COVID-19 was at its peak in the United States (or at least we thought). The Dow dropped below 20,000 for the first time since January of 2017.

At the time, I was working with a guy who was in his middle 60’s and was just waiting for the right time to retire.

I’ll never forget him looking at me one day and saying that his retirement account and pension were down over $250,000 in the last two weeks.

Luckily for him, he had plenty saved, but he ended up working an extra six months to give time to allow the market to rebound and come back.

He was lucky that it was short-lived because some recessions have lasted longer than 12 months.

Imagine planning to retire in late 2008 or early 2009 before the Dow dropped a record 777.68 in one day and closed at 10,365.45 on September 29, 2008. The market wouldn’t bottom out until February of 2009 and didn’t make a full recovery until September of 2010.

Some people ended up needing to work an additional 2-years just to ride out the plunging market to make sure they had enough to spend. Folks who could have retired at 65 or 67 years old were all but forced to work longer than they ever planned, to make sure they had the funds necessary to retire.

Longer life spans – Modern medicine advancement has brought the average life span much higher in the last 20 years.

This is fantastic, but it has caused the realization that you have to save more.

The rule of 25 only plans for 30-years of income. In some cases, it can last longer, but if you retire a few years early and go on to live a long life, you want to make sure you have plenty saved.

For young folks out there thinking, how can I spend that much money when I’m in my 90’s?

Remember, the cost of a nursing home or assisted living can get extremely expensive in a hurry. You can easily spend $20,000 to $30,000 a year just on living expenses.

Not only do you want to make sure you end up with living arrangements that you enjoy, you also don’t want to put any financial burden on your children or family members to make sure you are taken care of.

If you have good genes and other relatives that have lived long prosperous lives, you may want to think about planning for a rule of 30 or even more. It might be good to make sure you have plenty of retirement to live on.

Unexpected expenses – The last piece I want to cover that the rule of 25 doesn’t account for is unexpected expenses.

This could be major medical expenses from a hip replacement, stroke, heart attack, you name it. As you get older, you know medical bills are going to increase, but one major item could end up costing thousands of unexpected dollars.

The rule of 25 is also not meant for unexpected extravagant spending.

Typically, you are expected to have very little debt when you retire. You really shouldn’t have any car loans, and your mortgage should be finalized, or near the end of its life.

If you are wanting to make a huge retirement home purchase, or get a fancy convertible to drive around Florida, you need to plan for those accordingly. The rule of 25 may account for a small auto loan, but it certainly won’t provide enough income for a $500,000 retirement home unless you have planned on that from the beginning.

You’ll gain more and more discipline financially as you get older, but it is important to stick to the budget once you do retire.

The freedom of not working can always make you think you need more than you originally anticipated.

The key to retirement is to plan early and make sure you plan well enough to have enough money. The rule of 25 is a fantastic tool, especially in your early years when it’s difficult to budget 30 years down the road.

Just remember that at least once a year, you need to check the balances of your retirement accounts and evaluate if your projected monthly income is still accurate.

You don’t want to get to year 30 and realize you didn’t save enough. That could cause you to have to work a few years longer than you originally planned.

Updated: 11/14/2022