Your Retirement Number

A retirement plan needs a target: the size of the portfolio that can pay for the part of your spending that nothing else covers. This chapter explains the simplest way to estimate that number, what the estimate assumes, and how inflation, Social Security and market risk change it. The aim is a range you can plan around, not a single figure to the dollar.

The 25 times rule

The most widely used starting point is to divide the yearly spending your portfolio must cover by a withdrawal rate. At a 4% withdrawal rate that is the same as multiplying spending by 25, which is why it is often called the 25 times rule. The result is sometimes called a retirement number or, in the early-retirement community, a FIRE number.

If the portfolio must cover $50,000 a year, a 4.0% withdrawal rate gives a target of $1,250,000. Starting with $150,000 already invested and adding $1,500 a month, a portfolio growing at 3.9% a year after inflation reaches it in about 26.8 years.

Where does 4% come from? Bengen (1994) tested historical US market returns and found that a retiree who withdrew about 4% of the starting portfolio in the first year, then raised the amount each year with inflation, would not have run out of money over any 30-year period he examined. The Trinity study (Cooley, Hubbard and Walz, 1998) reached similar conclusions for portfolios with a large share in stocks. Both studies describe the past. Neither is a guarantee, and both looked at retirements of about 30 years.

How much the withdrawal rate matters

The withdrawal rate is the input that moves the target most, and choosing it is really choosing how much margin for error you want.

For $50,000 of yearly spending, a 4.0% rate needs $1,250,000, a 3.5% rate needs $1,428,571, and a 3.0% rate needs $1,666,667. Planning at the lowest of the three adds $416,667 to the target.

A lower rate makes sense when the retirement could last longer than 30 years, when you have little flexibility to cut spending in a bad year, or when you want more confidence that the money lasts. A rate near 4% is more reasonable for a retirement that starts in your sixties, especially if you can trim spending when markets fall. Chapter 7 returns to this choice from the spending side.

Inflation: thinking in today's dollars

Prices rise over time, so a fixed sum buys less each year. At 3% inflation, prices roughly double in about 24 years (by the rule of 72: 72 divided by 3). A target that looks large today will buy noticeably less by the time you retire, and less again by the end of a long retirement.

The simplest way to handle this is to do every calculation in today's dollars. State your spending at today's prices, and grow the portfolio at the real return, which is the return after inflation. That is what the examples in this book do: a 7.0% return with 3.0% inflation is treated as 3.9% of real growth. Your target then means "this much buying power", and you never need to guess what prices will be in thirty years. The real return calculator shows the conversion for any rates.

Social Security and pensions shrink the target

The portfolio only needs to cover the spending that other income does not. Social Security is the largest of these sources for most retirees, and a pension, an annuity or rental income can also count. Each reduces the yearly gap, and every reduction in the gap reduces the target by 25 times as much at a 4% rate.

If Social Security and other income covered enough of that household's spending to leave a gap of $30,000 a year, the target falls to $750,000 and the same saver reaches it in about 17.8 years.

Two cautions apply. Social Security retirement benefits cannot start before age 62, and someone who retires earlier must pay for the years in between from savings. And the benefit you receive depends on your earnings record and the age you claim, so use your own estimate rather than an average. You can see your estimate by creating an account at the Social Security Administration's website, and Volume 2 on this shelf covers when to claim.

What the simple number leaves out

The 25 times rule is a first estimate. Before relying on it, check four things.

1. Taxes. Withdrawals from traditional 401(k)s and IRAs are taxed as ordinary income. If most of your savings are in those accounts, the portfolio must cover your taxes as well as your spending. Chapter 4 explains which accounts are taxed and when.
2. Health care before 65. If you stop work before Medicare eligibility, you need to buy health insurance, and premiums can be a large line in the budget.
3. Sequence of returns. Two retirements with the same average return can end very differently if the bad years come first, because withdrawals during a fall lock in losses. Chapter 7 covers this risk and how retirees manage it.
4. Longevity. Plans fail more often from lasting longer than expected than from any single bad year. Planning to an age well past your life expectancy is the cautious choice.

Where you stand today

Once you have a target, compare it with what you have. A household that is far from the target is not behind in any absolute sense; what matters is whether the current saving rate and the years left are enough to close the gap. The FIRE calculator gives the years to your target from your own balance and saving, and the retirement savings by age benchmark shows how balances compare with others of the same age, which can be useful context but is not a target in itself.