Do These Retirement Rules of Thumb Actually Work?

By Justin Pritchard, CFP®

It can be tempting to do things the easy way. That’s understandable—there are only 24 hours in a day, and sometimes you just want to know what time it is without knowing exactly how a clock is built.

When it comes to retirement, you might have questions about some important topics.

  • How much money do you need for retirement?
  • What level of risk might be appropriate?
  • How long does it take to double your money?
  • How much income will you need?

While retirement planning rules of thumb can help you get some basic concepts down, there’s a risk of oversimplifying things. So, where are the grains of truth, and why might you need to look deeper?

Let’s review some of the most popular retirement-related rules of thumb, including the 4% “rule” and the rule of 100. We can’t dismiss these altogether, but they need to be used in moderation.
Continue reading below, or get similar information from this video.

The 4% Rule (or 25x Rule)

The so-called 4% Rule is possibly one of the most notorious rules of thumb for retirement planning.

This research finding suggested that:

  • You take the amount you have at retirement and withdraw 4% of that amount each year.
  • You invest in a 50/50 mix of stocks and bonds (or similar).
  • You adjust the withdrawal for inflation each year.
  • If all goes well, you should not run out of money over a 30-year retirement (using historical data, which can’t predict the future)

Example: Say you have $1 million on the day you retire. If you follow this approach, you plan to withdraw $40,000 in your first year of retirement and increase withdrawals each year for inflation. For example, if inflation is 3% in that first year, you add 3% to the following year’s withdrawal amount, resulting in withdrawals of $41,200.

Of course, there are no guarantees, and you can still run out of money with any withdrawal rate. But the 4% rule was a research project designed to figure out a “safe” withdrawal rate. Bill Bengen wanted to find the worst-case scenario in historical data and see how much retirees could have drawn from savings. In many cases, a higher rate was successful, but 4% was the lowest rate in his initial study.

The merits of this “rule” are debated elsewhere, and the study has evolved since the initial publication, but let’s focus on some basic pros and cons for the average retiree.

On the one hand, it helps you get a ballpark idea of the following:

  1. How much you might be able to withdraw from your retirement savings, or
  2. How much you might need to save to produce a desired withdrawal amount

This can be helpful if you have absolutely no idea how much money you might need in retirement. Some people assume they can withdraw 8%, 10%, or more every year over a typical retirement, which is probably unsustainable. By anchoring on a lower rate (even if it’s not the perfect rate), you might be able to keep realistic expectations.

On the other hand, this way of looking at withdrawals is far from perfect.

  • It ignores the fact that spending in retirement can be “lumpy.” You might need to buy a car or repair a roof in some years, while other years are relatively uneventful.
  • There’s no accounting for taxes. Pulling $40,000 from a Roth IRA is not the same as pulling $40,000 out of a pre-tax retirement account.
  • People may not spend in a flat inflation-adjusted pattern. The reality for most retirees is different.
  • You can potentially start with a higher rate if you’re willing to adjust your spending during market downturns. Making temporary cuts can go a long way.
  • A flat withdrawal rate doesn’t account for strategies like a Social Security Bridge, where you spend from assets at a relatively high rate before claiming Social Security benefits. After that, the rate typically drops (and you benefit from more guaranteed income and potentially some tax strategies).
  • You might not live through the worst-case scenario.

That last one is a biggie. While some people argue that 4% is too high (and they might be right), it could be too low. If returns are strong—no guarantees, of course—you could potentially withdraw more. Those extra dollars can help you enjoy life, live comfortably, and make memories.

Based on historical models, there were many periods when you’d actually die with more money than you started with when using a 4% rate. Of course, you need to balance the desire to live well with prudent behavior that can account for unknowns about health, longevity, and market returns.

Use the 4% number (or any other withdrawal rate) to see if you’re in the ballpark. If you’ll be far off from 4%, evaluate why. It could be perfectly fine to withdraw more or less as long as you have reasons for doing so.

25X Rule

Another way of using this rule is to figure out how much money you’ll need at retirement if you have a withdrawal goal.

Using a multiplier of 25 is essentially the 4% rule in reverse. We can change the example above, and the numbers will look familiar.

Example: You want to withdraw $40,000 per year from retirement savings to supplement your Social Security income. How much would you want to have saved up to accomplish that? With the 25X approach, you multiply the annual goal by 25 (25 times $40,000 equals $1 million). If you only need $12,000 per year to supplement other income sources, that equates to $300,000 of savings.

Rule of 100

How much risk is appropriate when you invest? One rule of thumb retirement savers lean on is taking your age minus 100 to determine how much stock to hold in your portfolio.

Like other rules of thumb, this has pros and cons.

On the one hand, it can make sense to reduce risk as you age. You have less time to recover from market downturns, and you’re more likely to be taking withdrawals (as opposed to adding money to your accounts and waiting for decades before withdrawing).

The conventional wisdom is that having high levels of exposure to stocks when you retire can be risky due to the “sequence of returns” problem. If the market crashes around the time you retire (or during the early years), every withdrawal takes a meaningful bite out of your assets. As a result, you may have a higher risk of running out of money.

At the same time, this rule of thumb assumes that everybody’s retirement situation is the same. Certainly, different people have different circumstances, and it might be appropriate for some to take more or less risk.

For example, if you can cover most (or all) of your costs with income from Social Security and pensions, you might view the risk question in one of two ways:

  1. You might not need to take much risk at all because you are already secure, so you could possibly put less toward stocks.
  2. You can afford to take risk because you’re not withdrawing from your assets, meaning you could potentially put more into stocks.

Or, what if you have cash reserves set aside for market downturns (alongside other investments that provide income in retirement)? While there are pros and cons of holding cash over the long term, that might be your preferred solution. If you conduct an analysis and find that that’s feasible, more power to you.

Similarly, you might choose to use bucketing strategies for risk management. That approach is also far from perfect, but it would require a different way of looking at things, and this rule of thumb would not apply in the same way.

There is even some research to suggest that you should actually increase stock exposure as you age. A reverse glide path (or “rising equity glide path”) could potentially work out better than a strategy that gradually approaches zero stock exposure.

As with other rules of thumb, you can use this to “take your temperature.” If your stock exposure is dramatically different, that’s not necessarily bad. The important thing is to notice it and ask yourself why.

Rule of 72

The Rule of 72 tells you how long it takes a number to double. This might be appealing if you want to know how long it will take to build up a desired level of savings.

For example, you might have $500,000 now, and you want to have $1 million in 15 years. If you’re curious whether or not that’s feasible, the Rule of 72 might help.

There are at least two ways to use this rule:

  1. Divide 72 by your expected annual return. The result is the number of years it takes an account to double.
  2. Divide 72 by the number of years until you retire. The result is the annual return you’d need for your assets to double in value.

Example: You will retire in 15 years, and your calculations suggest you’ll need twice as much as you currently have. What rate of return would allow your accounts to double? Divide 72 by 15 years for a result of 4.8%.

That’s helpful information, but it doesn’t tell the whole story.

The rule assumes you get the same return each period, which is unlikely with many types of investments. You can’t necessarily predict or control your future returns, and returns typically vary over time. That said, some fixed-income investments might offer enough certainty to do some calculations.

There’s also the issue of contributions. Your accounts can double faster if you’re still adding money to your retirement savings. For instance, if you deposit $20,000 per year in the example above, you’d reach the $1 million mark about five years earlier.

It’s also critical to account for inflation, as always. For example, do you need $1 million at retirement, or do you need an inflation-adjusted $1 million (which would likely be a higher number in future dollars).

Unfortunately, this is also an imperfect rule of thumb for retirement situations. Like the 4% rule, it ignores taxes and the types of accounts you have, among other things. Still, you can use this to quickly estimate how accounts might grow.

80% Replacement Ratio

The amount of spending you need to budget for is a big question. Some expenses change at retirement, while others are more or less the same (although inflation affects various expenses at different speeds).

One rule of thumb for retirement spending is an 80% replacement ratio. The exact level varies, but some people say you should plan to spend between 70% and 100% of your pre-retirement income.

The rationale behind replacement ratios is that your needs could change at retirement:

  • You’re no longer paying payroll taxes.
  • You stop saving money for retirement.
  • You might not commute or eat out as much, if that was part of your work day.

While those are reasonable assumptions, it’s probably too simplistic to assume that you’ll need less—and to assign a specific number without doing any analysis.

In reality, you might need significantly less or much more. It’s best to do robust retirement planning with your specifics in mind. You want to be mindful of your lifestyle, location, health, and other factors.

Instead of basing your goal on your pre-retirement gross income, it might make sense to use your spending as a foundation for any estimates. You can make a detailed budget, or you can make estimates based on your income, taxes, and savings levels. From there, you might make assumptions about how things could change in retirement.

Again, you’ll want to consider the possibility of changing spending levels in retirement. Whether you envision the go-go, slow-go, and no-go years or a retirement spending “smile,” a flat spending assumption might not be the right way to go.

Other Rules of Thumb

People use a variety of shortcuts to try to ease the process of planning. Keep in mind the following, as well:

  • Which accounts to spend from? Traditional conventional wisdom says to spend from taxable accounts, then pre-tax accounts, and then Roth accounts. But your details matter. Research which accounts to spend from first so you can manage taxes and other costs in retirement.

Important: Use rules of thumb or any of the information here at your own risk. A far better solution is to do customized retirement planning and investment analysis. You might be able to complete that with or without the help of a professional. If you are not certain that you have the ability to do it yourself, consult with tax, legal, and financial professionals before making any decisions.