Retirement Income Planning: The 4% Rule vs The 25X Rule | OneAZ Credit Union (2024)

Have you ever wondered how much money you need for retirement? Whether your retirement isyears away or just around the corner, it’s important to do retirement income planning throughout your life.

Unfortunately, there isn’t a foolproof way to determine an exact amount because there are so many factors toconsider, like:

• What age will you retire?
• What is your life expectancy?
• What does the economy look like when you retire?
• Where will the economy be during your retirement years?

The good news – there are two retirement income planning rules that can help point you in the right directionbased on the one thing we can measure – the past.

Both the 25X Rule and the 4% Rule can give you a great starting point todetermine what you need to do now to have enough money at retirement, and then what you’ll need to do inretirement to make that money last.

The 25X Retirement Rule for Retirement Income Planning

The 25X Rule states that you’ll need 25X of your annual spending set aside at retirement toretire comfortably.

To start, determine how much you spend in a year. The best way to do this is by looking at your expenses for amonth, then multiplying that total number by 12.

For example, if you spend $5,000 per month, then you know you’re spending $60,000 per year. Next, multiply yourannual spending of $60,000 by 25 to get your nest egg amount of $1.5 million.

Flaws with the 25X Rule

The 25X Rule is simple to calculate, but there are some flaws to be aware of. For starters, it doesn’t takeinflation into consideration. And with inflation being at historical highs over the past two years, this woulddefinitely throw off your calculations.

Another flaw is that the 25X Rule does not utilize other sources of income you may have in retirement. Forexample, the majority of retirees will have social security, some will have a pension, and others still may haveother forms of income.

While the 25X Rule is a great starting point to determine how much money you need for retirement, our next ruleholds a lot more weight for retirement income.

The 4% Rule for Retirement Spending

How the 4% Rule for Retirement Works

Let’s assume you have $1 million saved when you enter retirement. The 4% Rule states that first year you wouldwithdraw 4% to be used for income, or a $40,000 income. Then in the following years, you would adjust forinflation.

For example, if inflation in year two of retirement is 6%, then your withdrawal would increase to$42,400.

If in year three inflation was 3%, then you would adjust accordingly to$43,672.

Although unlikely, if inflation was negative the next year at -2%, then your income would dropto $42,798.

The important thing to remember is Bengen proved that when someone retired any year between 1926 and 1976 andused the 4% Rule, 80% of the time their nest egg lasted 50 years or more and 100% of the time it lasted 35 yearsor more.

With the averageretirement age in the United States at age 64 and the average life expectancy at 77 years old, you cansee the 4% Rule leaves plenty of room to have enough income in retirement.

What About the Next Financial Downturn?

Many Americans are concerned about the effects of another economic downturn either right before retirement oreven worse — during retirement.

For most people looking at retirement today, they lived through the Savings and Loans Crisis of the late 1980s,the Dot Com Bubble from 2000 - 2002, the Great Recession from 2007 - 2009, COVID-19 and the downturn as recentas 2022-2023.

With that said, Bengen’s study shows the effects of three of the most significant economical disasters between1926 and 1996 to be used for comparison to modern-day financial disasters:

Bengen’s Three Major Financial Disasters Between 1926 and 1996

*Chart data collected from Bengen’s Paper in theJournal of Financial Planning.

The chart above shows that even during some of the worst financial disasters in the UnitedStates’ history, a retiree’s income would have lasted 35 to 50 years in retirement regardless of when theyretired.

This means if someone retired right before, or even during the Great Depression, and utilized the 4% Rule, theirnest egg would have lasted throughout their retirement. Even during the 1970s, when inflation was at historicalhighs, someone using the 4% Rule would still have made it through their retirement years.

Now let’s look at the three recent financial disasters over the past 25 years to get a comparison to themodern-day retiree.

Three Major Financial Disasters Between 1996 and 2022

*Chart data collected from macrotrends.net

In comparing both charts above, there are a lot of similarities to the financial disastersfrom those earlier years to the same ones we’ve experienced more recently. No one knows what tomorrow will looklike and it’s always wise to seek out help from a Certified Financial Planner to help navigate you to andthrough retirement.

Retirement Income Planning FAQs

What Happens if I Use a 5% Rule for Retirement Income Planning?

Although one percent doesn’t seem like a lot, it actually had drastic consequences when applying a 5% withdrawalrate that first year in Bengen’s study. For example, if someone were to retire in the late 1960s or early 1970s,their nest egg would have only lasted 20 years. When going up to 6% withdrawal rate, there were periods of timewhere the retiree’s nest egg lasted less than 20 years.

What Is Inside the Nest Egg During Retirement?

Bengen recommended using a mixture of 50% stocks and 50% bonds during retirement years. However, many retireestoday believe having that much of their nest egg in equities (stocks) during retirement is too risky.

According to Bengen, those who went less than 50% stock mixture did not end up as well in the study as those whohad at least 50% of their retirement nest egg in stocks.

In fact, when Bengen modeled the study with a 75% stocks to 25% bonds portfolio, often the nest egg not onlyoutlasted the more conservative mixture, but also outperformed it in terms of growth.

Is the 4% Rule Becoming Outdated?

Many financial professionals agree that 4% may be too aggressive in today’s standards. However, this has a lot todo with people retiring at a much younger age and life expectancy increasing as time goes on. If you findyourself facing a retirement that could last longer than 35 to 50 years, consider dropping to between 3% and 4%for your new retirement income planning rule.

Final Thoughts

As you’ve learned by now, retirement is not an age, it’s a number.

When using both the 4% Rule and the 25X Rule, take a moment to determine what you want your retirement to looklike in the future. Ask yourself what your expenses will be, how much income you’ll need each month, and howmany years you’ll be retired.

Once you have your retirement rules calculated, it’s time to create the plan to help youachieve your retirement goals.

Table of Contents

• Intro
• The 25X Retirement Rule for Retirement Income Planning
• The 4% Rule for Retirement Spending
• What About the Next Financial Disaster?
• Retirement Income Planning FAQs
• View related articles

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