So, you’ve decided to start saving for retirement. How much money will you need to save up?

TL;DR: You need about 25 times your retirement spending invested in a 50% stock / 50% bonds portfolio for a 30 year retirement. Put another way, you can spend about 4% of your initial portfolio balance per year. For a 50+ year retirement, plan on 3.5% (or save 28.5 times your spending) and have 60-75% stock.

Retirement Spending vs. Pre-Retirement Income

Notice that the rule of thumb above is a multiple of your retirement spending, not your pre-retirement income. How are they different?

In retirement, you will (or can) have:

  • No payroll taxes (Social Security and Medicare Tax; 7.65% of your gross pay)
  • Much Lower Income Tax (for us, about 20% income tax when working to less than 2% retired)
  • No mortgage (pay off your house first)
  • No retirement saving (you finished that already)
  • No kids to support (if you have some still at home now)
  • Health Care to pay for (via Medicare or the ACA Exchange)

See our example couple, who earns $100k and goes from paying $15.1k tax when working to $3.7k or less in retirement.

Your retirement spending is likely to have a lot of other small differences - maybe more spending on hobbies but less on gas since you’re not commuting - but they are hard to predict before you make the leap into post-work life.

You may be tempted to try to make a precise estimate, but unless you’re quite close to retirement, a lot is likely to change between now and then. To get an initial idea of the income you’ll need in retirement, take your annual income and take out taxes, your mortgage, and your current retirement savings, and add back property taxes. When you start getting close to retirement, you can get more precise by getting current health insurance costs and subsidies for your planned income and adding any remaining mortgage payoff amount, among other things.

Don’t Forget Social Security

It’s easy to dismiss Social Security as an income source. You may think Social Security won’t be there when you retire, that it will start paying too long after you retire, or that it will not cover much of your spending, but it’s worth looking up your benefit and factoring it in. You can find your income history from your Social Security statement, then fill in the Social Security calculator to see your benefit with no further contributions.

In 2021, a couple taking Social Security at age 70 with the maximum benefit would get $93,480 per year. Even half of that covers a significant retirement budget when there is no mortgage and minimal taxes to pay. In our case, even with only half-length careers, we’ll still get 75% of the maximum benefit. Social Security pays more of lower incomes, so your last working years increase your benefit much less than the first ones.

What if you plan to retire at 40, waiting 30 years to start your maximum Social Security benefit? Crucially, it means most of your portfolio only has to last 30 years instead of 60, making 4% a much safer spending rate. If your budget is higher than the benefit you’ll get, you need to set aside a “mini-portfolio” to cover the remaining spending, but that part has 30 years to grow untouched.

Where is the 25x spending or “4% Rule” from?

Back in 1994, retirement planners didn’t have a consistent answer to the “how much do I need” question, and a financial planner named William Bengen decided to come up with a definitive answer.

He assumed a family would:

  • Choose an initial income upon retiring, then increase it for inflation every year.

  • Invest half in stock (an S&P 500 index) and half in bonds (10 Year Treasuries).

  • Take out spending money and trade back to 50% stock and 50% bonds each year.

  • Need the money to last for 30 years.

Bengen looked at historical investment returns and inflation rates to find the highest initial income that lasted for 30 years even in the worst starting year in his data set. The worst year turned out to be 1966, where low returns and high inflation caused a lot of trouble right at the beginning of retirement, and in that year, choosing a starting income of 4% of the initial portfolio just barely lasted 30 years. He published ‘Determining Withdrawal Rates Using Historical Data’ with his findings.

While this analysis is simplistic, it’s a great starting point for planning and has become widely accepted in the financial planning industry.

Issues with the 4% Rule

You might wonder what the safe retirement spending (often called the SWR, or safe withdrawal rate) should be in different circumstances. For example:

  • What about retirements longer (or shorter) than 30 years?
  • What if you cut your budget in bad years?
  • What if you don’t trade back to 50% stock / 50% bonds each year?
  • What about stock percentages other than 50%?
  • What if you add other investments (international stock, gold, real estate)?

These details matter, and they have been studied extensively. Since there are so many ways to handle the details, the more recent results really haven’t gotten the same broad acceptance as the original analysis.

If you’re a long way from retirement, my advice is not to try to get overly precise. Use 4% as a planning number to estimate your retirement needs (and date) and come back for the details when you’re getting close to retirement day. For retirements of 50 years or longer, a rate closer to 3.5% is safer, though income later in retirement (see Social Security, above) and flexibility (see below) can make 4% fine even for long retirements.

If you want an in-depth analysis, check out Living Off Your Money by Michael McClung. McClung summarizes a lot of different research about how to invest, how much you can spend, and tactics for how to take the money out. It’s hard to know how well a strategy really works until it’s been around for ten years or so (with returns that the researcher didn’t use to design the strategy), so be skeptical of results much higher (or lower) than the norm.

Flexibility is Key

Probably the most unrealistic simplification of the 4% rule is that people would just pick an income on retirement day and then take an inflationary raise every year, completely ignoring the world around them.

If you’re willing to skip raises, make spending cuts, or delay bigger purchases when returns are bad, research finds that you can use a distinctly higher initial spending rate (5.4% according to Guyton and Klinger).

Often, if a retirement portfolio fails, it’s because returns at the very beginning of retirement are bad (or inflation is high) and the portfolio can’t grow enough to fund spending and recover. This means that delaying retirement if a crash happens right before you quit or doing a little consulting work at the beginning of a rough retirement makes a huge difference.

Overall, if you’re flexible and ready to make some changes as your retirement unfolds, it’s really not too hard to safely navigate retirement even with a spending rate that seems a little high on paper. That’s what people did before Bengen came along in 1994, and it works, too. =)