The Multiply By 25 and 4 Percent Retirement Rules

Never Confuse These Two Retirement Rules of Thumb

A Man Working at the Kitchen Table With a Calculator and Laptop
•••

Geber86 / Getty Images 

As you plan for how much money you'll need in retirement, there are two popular rules of thumb that can outline the answer for you. The "Multiply by 25" rule and the "4 Percent" rule are often confused with one another, but they contain a critical difference: one rule of thumb guides how much you should save, while the other estimates how much money you can safely withdraw. Here's an in-depth look at each of these so you're clear on both.

Multiply By 25 Rule

The Multiply by 25 Rule estimates how much money you'll need in retirement by multiplying your desired annual income by 25.

For example, if you want to withdraw $40,000 per year from your retirement portfolio, you need $1 million dollars in your retirement portfolio. ($40,000 x 25 equals $1 million.) If you want to withdraw $50,000 per year, you need $1.25 million. To withdraw $60,000 per year, you need $1.5 million.

This rule of thumb estimates the amount that you can withdraw from your portfolio. It does not factor in other sources of retirement income, like any pensions, rental properties, Social Security, or other income.

This rule of thumb assumes you'll be able to generate an annualized real return of 4 percent per year. It assumes that stocks, over the long run (15-20 years or more), will produce annualized returns of roughly 7 percent.

Investing legend Warren Buffet predicts the U.S. stock market will experience 7 percent long-term annualized returns over the next few decades. Meanwhile, inflation tends to erode the value of the dollar at roughly 3 percent per year. It means your "real return"—after inflation—will be about 4 percent.

The 4 Percent Rule

The 4 Percent Rule is often confused with the Multiply by 25 Rule, for obvious reasons—the 4 Percent Rule, as its name implies, assumes a 4 percent return.

However, the 4 Percent Rule, more importantly, guides how much money you can withdraw annually once you're retired, without cutting into your investment principal. As the name implies, this rule of thumb says you should withdraw 4 percent of your retirement portfolio the first year.

For example, you retire with $700,000 in your portfolio. In your first year of retirement, you withdraw $28,000. ($700,000 x 0.04 equals $28,000.) The following year you withdraw the same amount, adjusted for inflation. Assuming 3 percent inflation, you should withdraw $28,840. ($28,000 x 1.03 equals $28,840.)

The $28,840 figure might be more than 4 percent of your remaining portfolio, depending on how the markets fluctuated during your first year of retirement. Don't worry about that—you only need to calculate 4 percent once.

The guideline says you should withdraw 4 percent during your first year of retirement, and continue withdrawing the same amount, adjusted for inflation, each year after that.

The Difference

The Multiply by 25 Rule estimates how much you'll need to have in your retirement portfolio when you're ready to retire. This is also the amount to which you would apply the 4-percent rule. The 4 Percent Rule estimates how much you should withdraw from this portfolio after you're retired.

The Accuracy of These Rules

Some experts criticize these rules as being too risky. It's unrealistic to expect long-term annualized 7 percent returns, they say, for retirees who keep most of their portfolio in bonds, CDs, and cash, which are safer but tend to have lower returns.

People who want a more conservative approach opt for a Multiply by 33 Rule and a 3 Percent Rule. Multiplying by 33 assumes you'll have a "real" return—after inflation—of 3 percent. That represents a 6-percent long-term annualized gain, minus 3 percent inflation.

The 3 Percent Rule advocates withdrawing 3 percent of your portfolio during your first year of retirement. A person with a portfolio of $700,000 would withdraw $21,000 during the first year of retirement, adjusting for inflation to $21,630 the second year.

Some dismiss this approach as too conservative, but others argue that it's appropriate for today's retirees who are living longer and want manageable levels of risk in their portfolio.

Adjusting for Inflation

Here's an important follow-up detail: You will need to adjust these numbers for inflation, especially if you're several decades away from retirement. Here's a quick summary: 

  • If you're 10 years from retirement, multiply by 1.48.
  • If you're 15 years from retirement, multiply by 1.8.
  • If you're 20 years from retirement, multiply by 2.19.
  • If you're 25 years from retirement, multiply by 2.67.

Assume that you want to withdraw $80,000 per year from your retirement portfolio, and you're 25 years away from retirement. Multiply $80,000 x 2.67 = $213,600 to arrive at your inflation-adjusted target.