How Much Money Do You Need To Save For Retirement?
How much money do you really need to save to retire comfortably?
For many people, this question causes a lot of anxiety. On the one hand, you want to save enough so that you don’t run out of money after you’ve stopped working. Your retirement account should be large enough to cover you for the rest of your life and, if you so desire, leave some inheritance for your kids, grandkids, and anyone else important to you.
But at the same time, you don’t want to save so much that you can’t possibly spend it all during retirement. It’s a fine balancing act – ensuring you’re saving enough for retirement without undermining your quality of life right now.
Conventional wisdom is that you should save approximately 10% to 15% of your income each year. Most financial experts agree that if you save that much, you should be able to retire comfortably.
Of course, this is dependent on your personal goals and vision for retirement. For some people, that might be perfectly enough! But for others who want to travel the globe in their golden years, that budget might be stretching it thin.
Let’s explore some factors to consider in your retirement planning.
Retirement Planning: Understanding the 25X Rule
One of the reasons I like the 25X rule is because it starts from a budgeting perspective.
Compare that to conventional wisdom. Sure, it’s great to save 10% to 15% of your income each year, but that formula leaves you feeling… a little uneasy. Why? Because it doesn’t account for your retirement budget at all. It’s a one-size-fits-all solution, and we all know that life isn’t that simple.
Instead, the 25X rule begins with you.
First, you need to determine your estimated retirement income. For most people, this is 80% of their pre-retirement income. Let’s say that you earn $100,000 a year. By following this rule, it would assume that you would need $80,000 in retirement.
You won’t be paying income taxes or other job-related expenses. Also, by this point, your home and vehicles will likely be paid off, so your retirement income needs will be much less.
Whatever your retirement income goal is, you should multiply that by 25 (this is why it’s called the 25X – or 25 Times – rule).
So using this example, you would need $2 million to retire comfortably.
$80,000 x 25 = $2,000,000.
But how do you make sure your money doesn’t run out? How do you ensure that you don’t spend too quickly and deplete your retirement savings too quickly?
The second half of the 25X rule is that you should only withdraw 4% annually from that retirement savings pot.
By limiting yourself to a 4% withdrawal rate annually, your retirement savings will last for the rest of your life!
In short:
- Multiply your expected retirement income by 25.
- Only withdraw 4% annually from your retirement savings.
Why Use the 25X Rule When Planning for Retirement?
While it’s good advice to save 10% to 15% of your income for retirement, the reason I love the 25X rule is that it takes a budget-first approach.
In other words, you are saving for your specific budgetary needs.
Think about it this way: only you can determine what your retirement looks like. Do you want to travel? Do you want to learn new hobbies? If you live in the north, are you planning on purchasing a second house down south to escape the bitter cold winter months? Do you plan on collecting things (such as antique cars) during retirement?
The 25X rule provides stability because rather than saving for an undefined goal, the 25X rule helps us specify our goal savings amount. It’s impossible to follow the 25X rule without knowing what your projected annual retirement income will be.
It comes down to knowing how much money you’ll need in retirement.
For most people, 80% of their pre-retirement income will be perfectly fine and you can plan and save accordingly.
Here are some other factors to consider:
- When do you want to retire? If you want a “normal” retirement, then odds are that you’ll want to retire around age 66, which is when you’ll also receive your full social security benefits. However, more and more people are wanting to retire early. You may have even heard of the FIRE (financial independence, retire early) movement. If you want to retire early, then you’ll have to save more aggressively and intentionally than someone planning a traditional retirement.
- When did you start saving for retirement? The earlier you start saving, the more that compound interest will work in your favor. $100 invested in your 20s is going to be worth a lot more in retirement than $100 invested in your 50s. If you didn’t have a chance to start early, don’t blame yourself. There are many reasons why it’s difficult to start young, such as paying off debt and trying to get established in your career. However, it’s never too late to get started. Now is better than never!
- Don’t forget about your emergency fund. When an emergency comes, it might be tempting to dip into your retirement fund, but an emergency fund and retirement savings should be two separate things. In general, you should keep 3 to 6 months’ worth of living expenses in your emergency fund. Also, the money should be easily accessible (not in stocks) so you can easily withdraw in the event of an emergency.
By taking all of these factors into consideration, you can approach your retirement with confidence!
Are There Any Downsides to the 25X Rule?
Like with any piece of financial advice, it’s best to take the 25X rule with a grain of salt. It’s impossible for any “rule of thumb” to take every factor into consideration. For example, this rule doesn’t factor in sources of income outside of your retirement fund, such as pensions, social security, and part-time side jobs.
Another factor that is impossible to plan for is unexpected life events such as health issues that can incur hefty medical bills. It’s also impossible to predict what inflation and market performance will look like, but these are challenges that affect any retirement savings strategy.
Final Thoughts
To save for retirement, it’s important to begin getting your budget in order. This is key to increasing your financial confidence while keeping stress levels as low as possible.
Retirement might seem forever away, but I think we can all agree that time flies fast… and seems to be going faster.
The younger you start saving for retirement, the “easier” it will be with compound interest on your side. But don’t let that discourage you if you’re starting later. Remember, it’s better late than never, especially when it comes to retirement planning.
This post originally appeared at The Budget Mom.
Category: Personal Finance
