Transcript
Most retirees I talk with have numbers in their heads and rules they've been told to follow. We all want to play by the rules of the game, but in retirement, which rules do you follow? Today, I'm going to walk you through three industry-standard rules you've probably seen online or discussed with friends so you can see how they apply to your real-life retirement. The three rules are the rule of 72, the rule of 55, and the rule of 25.
What Is the Rule of 72 and How Does It Work?
Let's start with the rule of 72. The rule of 72 is the one that makes you feel like a math genius because it lets you calculate compound interest in your head. Here's how it works.
Take the number 72 and divide it by your rate of return. Whatever you get is roughly the number of years it takes your money to double. So if your money's growing at around 7% a year, 72 divided by 7 is about 10, which means your money doubles roughly every 10 years.
Growing a little faster, say around 9%, that means your money doubles closer to about every 8 years. Okay, so why does this matter in retirement? Because it reframes how you think about time. A lot of people hit their 60s and assume their growing is over and that it's all downhill from here.
Why Does the Rule of 72 Matter in Retirement?
But if you're retiring at 62 and there's a good chance you're going to live into your late 80s, that's more than 25 years of life ahead of you. That's enough time for money to double and maybe even double again. So the rule of 72 isn't a rule that tells you what to do.
It's a rule that reminds you that your money doesn't stop working the day you stop working.
What Is the Rule of 55 for Retirement?
The next one is the rule of 55. And this one is about access, specifically getting to your money without getting slapped with an IRS penalty.
Here's the background. Normally, if you pull money out of a retirement account before age 59 and a half, the IRS tax on a 10% early withdrawal penalty on top of your regular taxes. That penalty is what keeps most people from touching those accounts early.
How Does the Rule of 55 Work for 401(k) Withdrawals?
So the rule of 55 is the exception. If you leave your job, you retire, you get laid off for whatever reason, in or after the year you turn 55, you're allowed to take money out of that employer's 401k without a 10% penalty. Notice the fine print there because it trips people up.
It has to be the 401k at the job you just left. It doesn't apply to old 401ks from previous employers. It doesn't apply to IRAs.
Does the Rule of 55 Apply to an IRA?
In fact, if you roll the 401k into an IRA, the moment you retire, which is what a lot of folks do, you can give up this option. So the rule of 55 is really a rule about timing and sequence. For someone who wants to retire a few years before that 59 and a half line, it can be a bridge that gets them there.
Whether it's the right move for you depends on your whole picture. But now at least you want to know the door exists before you close it. Now we get to the big one.
What Is the Rule of 25 for Retirement?
The rule that tries to answer the question everyone's asking: how much do I need in retirement? The rule of 25 says you take the annual income you want your portfolio to provide and multiply it by 25. That's your target number. So if you want your investments to generate $40,000 a year, the rule of 25 says you're aiming for a nest egg around a million dollars.
You want it to throw off $80,000 a year, you're looking at roughly 2 million. Here's what I want you to understand about this rule. The rule of 25 is really the flip side of another rule you've probably heard.
What Is the Difference Between the Rule of 25 and the 4% Rule?
The 4% rule. The idea that you can withdraw 4% of your portfolio each year and have a good chance of it lasting. Multiplying by 25 and withdrawing 4% are basically the same math, just wearing different outfits.
What Are the Limitations of the Rule of 25?
And that's exactly why I've cautioned you not to treat this rule as gospel. The rule of 25 assumes a lot. How long you'll live, how the markets will behave, how you're invested, how steady your spending stays.
It doesn't know that you've got a pension or social security or your spending will be high early in retirement when you're traveling and lower later on. It's a starting number, not a finish line. So the rule of 25 to get you to the right ballpark, just don't let it convince you that you're not ready when you might be or that you're fine when you might need a closer look.
How Should You Use Retirement Rules of Thumb?
So those are the three rules. And I want to leave you with the most important point of this whole video is that every one of these rules is a shortcut. They take something complicated and give you a number you can hold in your head.
The rule of 72 is about growth. The rule of 55 is for access. The rule of 25 for your target.
Shortcuts are generally useful and they get you oriented and they get you in the ballpark. They give you a way to sanity check what you're hearing. But remember that not one of them knows your unique situation, your pension, your health, your spouse, your social security timing, or what you actually want your retirement to look like.
Retirement Rules of Thumb vs. a Personalized Financial Plan
So play by the rules, use them as a way they're meant to be used as a starting point as a way to ask better questions. Just don't confuse the rule of thumb with financial plan, learn how to create a strategy built around your life. Visit us at fontaine-retirement.com or contact us at 305-386-7667.