Reconciling Three Retirement Goals: 25X Expenses, 20X Income, 0.5% Withdrawal

There are three retirement goals to shoot for in order to comfortably walk away from your day job and remain retired. They are:

  1. Accumulate 25X your annual expenses
  2. Accumulate 20X your annual household income
  3. Be able to live off a 0.5% annual withdrawal rate

Instead of viewing these retirement goals as at odds with each other, view these retirement goals along a spectrum. They were all introduced at different times in history to address different economic conditions.

Let’s review them one by one and see how they can apply on your financial journey.

Retirement Goal #1: Achieving 25X Your Annual Expenses

The baseline retirement goal is to build a liquid net worth equal to at least 25X your annual expenses before you retire. A liquid net worth excludes the value of your primary residence.

If however, you can generate income from your primary residence by renting out rooms, then I suppose you can include your primary residence’s value in your 25X calculation.

25X is the inverse of 4%. 4% is the longstanding safe withdrawal rate that has been espoused since the mid-1990s. I believe the 4% rule is outdated, which is why accumulating 25X your annual expenses is the minimum net worth amount to achieve before retirement can truly be considered an option.

Accumulating a net worth equal to 25X your annual expenses is the easiest goal, but it is also the most aggressive goal to live off. The reason why it’s the easiest goal is because expenses can be reduced to more easily achieve the goal.

For example, let’s say your desired lifestyle is spending $40,000 a year. You would, therefore, need to accumulate a net worth of at least $1 million to retire.

But if you wanted to cheat, you could lower your expenses to $20,000 and pretend your life would still be as great living on half as much. As a result, you may tell yourself that you only need $500,000 to walk away from your job.

You can pretend your ideal living situation is only eating boiled eggs with raw onion for dinner in a studio apartment in your 40s. However, deep down, you know you would love to live in at least a one-bedroom so you and your partner don’t drive each other crazy during future lockdowns.

25X Expenses Is Not Enough To Feel Secure

Here’s the thing. I don’t know anybody who retired with 25X their annual expenses who isn’t frantically working to make more money. The majority of people who only have a net worth equal to 25X their annual expenses have simply changed careers.

I also don’t know anybody who retired with 25X their annual expenses who is truly living their best lives. Besides lowering housing and food standards, there may be other sacrifices such as travel, charity, and even family formation.

Given these two big reasons, I recommended giving yourself a high-five once you’ve achieved 25X your annual expenses. Then, come up with a plan to accumulate a net worth equal to 20X your annual household income.

Related: The Curious Case Of Retiring And Living In Abject Poverty

Retirement Goal #2: Net Worth Equal To 20X Your Household Income

Achieving a net worth equal to 20X your household income is the main retirement goal everyone should shoot for today. It is a net worth target I came up with in 2016. The income to base your calculation on is the average of your three highest income-earning years.

Not only is the 20X income goal based on logic, I’ve also carefully monitored how it stacks up through the course of my retirement. So far, it’s held up reasonably well, although it’s being challenged in 2020+.

The significance of the 20X income goal is that it prevents you from cheating. You can’t lower your expenses to achieve your net worth target quicker. Instead, you are forced to always stay disciplined the more you make.

The Focus On Investment Income

There’s a natural tendency to spend more the more you make. By following the 20X income goal, you also become more focused on making more money through your investments.

Conversely, with the 25X expenses goal, you may be more focused on reducing expenses.

Since day one of this site in 2009, I’ve always emphasized making money over cutting expenses as the best way to build wealth. You can only cut so much, but the amount you can make is unlimited.

More Satisfying Achievement

The 20X income goal is also great because the more you make, the more challenging your net worth target gets. With the 25X expenses goal, the more you make, the easier your net worth goal becomes. As a result, if you achieve a net worth equal to at least 20X your income, you will feel more satisfied.

Not only will you feel more satisfied with your accomplishment, you will also feel more at ease in retirement. You won’t feel as great of a need to make supplemental retirement income if you don’t want to. However, you will probably end up doing something due to your interests and desire to be productive.

For example, I enjoy playing tennis, teaching, and meeting new people. Therefore, before I had kids, I decided to give private tennis lessons once or twice a week sporadically. Each lesson earned me $80, which was nice beer money.

Retirement Goal #3: Withdrawing Only 0.5%

The final retirement goal is one that is practiced after you leave your day job. Once you’ve accumulated a net worth equal to 20X your income, I recommend withdrawing no more than 0.5% of your portfolio during your first three years of retirement.

You want to stay conservative during your initial retirement years because you’re still trying to figure out how to live your new life and spend your capital. Further, the earlier you retire, the greater your uncertainty of whether you did the right thing.

Withdrawing only 0.5% a year may sound aggressive, but it is aligned with the times of permanently low interest rates. It takes much more capital to generate the same amount of risk-adjusted income. Therefore, it’s wise to lower your safe withdrawal rate accordingly.

As I wrote in my Proper Safe Withdrawal Rate post, one of the reasons why the 4% rule is outdated is because when it was proposed, the risk-free rate was between 5% – 6.5%. Therefore, it doesn’t take a PhD to know that withdrawing 1-1.5 percentage points below a guaranteed rate of return is safe.

After a lifetime of accumulating wealth, withdrawing money will feel foreign. Therefore, it might not be as hard as you think to keep your withdrawal rate at 0.5% or less.

Retirement is a very emotional process. It doesn’t fit neatly into a model.

Retirement Goals: Interest rates are way downRetirement Goals: Interest rates are way down

200X Expenses

The flip side to a 0.5% withdrawal rate is trying to accumulate a net worth equal to 200X your annual expenses. In other words, if you are comfortable living off $50,000 a year, you would need to amass a $10 million net worth. If you do so, then you can more easily withdraw 4% or more.

Intuitively, we understand that $10 million is unnecessary for a $50,000 a year spender. Even if there is a 10-year bear market that wipes away 70% of your net worth, you’ll most likely still be fine with $3 million if you keep spending the same.

After all, to live off $50,000 a year is like making $70,000 a year in gross income. If you follow my 20X income goal, then all you would need is $1.4 million, let alone $3 million.

Therefore, instead of focusing on accumulating a net worth equal to 200X expenses, focus on lowering your safe withdrawal rate when you are retired. The only way to lower your safe withdrawal rate is to earn supplemental retirement income, hopefully through work that gives you purpose.

Finding Purpose Is Important

What the retirement models and researchers won’t tell you is that once you retire, your desire for having a purpose will dramatically increase. Given your identity is no longer wrapped up in your career, there is a void you will want to fill.

One of the best solutions is to do something purposeful that also provides income in retirement. This activity can be as straightforward as being a Walmart store greeter for three hours a day. It not only feels good to help people find their way, but it’s also nice to be part of a community.

The community aspect cannot be underestimated. Perhaps lockdowns have highlighted how important community really is. The desire to be a part of a greater group is why I joined a tennis club and a softball league. It is also why I became a high school tennis coach for 3-4 months a year.

You may wonder why people who come up with these retirement models don’t talk more about the importance of purpose and community. The reason why is because these modelers hadn’t experienced retirement yet when they came up with their models: they were all working.

I’m giving you perspective in real-time after not having a job for more than eight years. Withdrawing any amount of capital each year after spending 20+ years saving may be harder than lifting Thor’s hammer.

Related: The Negatives Of Early Retirement Nobody Talks About

Example Of Using Retirement Goals On A Spectrum

After reading more about these three retirement goals, I wanted to share an example of how you can implement using this below case study from a reader:

$155k – annual spend
$90k – annual income from a side hustle
$3,000,000 – net worth excluding house and 529.

Do you think that’s enough?

Depending on age, this reader is very close to being able retire without much worry. Using the baseline retirement goal of 25X expenses, he would need a minimum net worth of $3,875,000 versus his current liquid net worth of $3,000,000.

However, his $90,000 a year side hustle is very significant income. If the side income is defensible, enjoyable, and has an equity component to it that can be capitalized, its value can be added to his existing liquid net worth to get closer to $3,875,000.

Alternatively, he could take his $155,000 annual spend and subtract $90,000 to get $65,000. 65K equals about $95K in gross income. Using my 20X income goal would mean he would only need a $1,900,000 net worth to retire comfortably.

By withdrawing 0.5% from his current liquid net worth of $3 million, the reader can add $15,000 a year to his $90K side hustle income and live off $105,000 for at least the first year post retirement. It’s not the $155,000 annual spend he is used to. However, he can challenge himself for at least one year post retirement to try and generate more side hustle income and/or reduce his expenses.

A Plan Before Retirement

If I were the reader and wanted to retire soon, I would circle a date one year into the future. During the next 12-months I would:

  1. Save and invest a record amount
  2. Boost side hustle income
  3. Develop better relationships with my manager and HR
  4. Reduce risk exposure
  5. Strategize a severance negotiation

Getting a severance package could be the x-factor that makes retiring a no-brainer. If the reader can get a severance equal to at least 6-12 months of living expenses, that will significantly reduce downside risk and worry. Further, it will provide for a nice winning sensation that he will have left on his terms with money in his pocket.

Retirement Will Be Different Than You Imagine

However much you think you will need in retirement is likely not what you will actually need in retirement.

Personally, I found that I needed less money in retirement because there were so many free things to do. Further, once you retire, you don’t have to save for retirement. However, after retirement, I had not one kid but two kids. Each were miracles. The amount of money I needed for both my wife and I to stay retired ballooned higher.

Whatever you think your retirement life will be like will probably not be what your retirement life will really be like either.

Before I left work, I imagined going surfing and snorkeling every morning in Hawaii. Then I envisioned I’d eat an amazing lau lau for lunch, take an hour nap, and go play tennis or golf in the afternoon. My body would be ripped, my skin would have a uniform golden brown color, and I would be free.

Instead, I’m still in San Francisco eight years later. I’m certainly not ripped either. My days are mostly spent taking care of my two kids and writing. I still play tennis and softball 3X a week, but it’s a different life than what I had managed. Inertia is hard to break.

Expect an unpredictable journey. Don’t think about these various retirement goals or “rules” as absolutes. Instead, think about them as part of a spectrum. Over time, your retirement goals and the amount of money you feel comfortable having will evolve.

Stay flexible in your beliefs. And most of all, please enjoy the journey!

Use A Retirement Planning Calculator

Another reader mentioned that the only way he gets clarity of his financial projections is to do a long-term cash flow forecast. He accounts for every dollar coming and going, which he says is useful with ad-hoc income such as income from alternative investments and ad-hoc costs such as a roof replacement. He asked me my thoughts on this approach.

It sounds tedious, but I agree that doing a long-term cash flow analysis with potential ad-hoc income and cost items is smart. But instead of doing so manually, I use Personal Capital’s Retirement Planner, which was created exactly for this purpose. It automatically tracks your income and expenses. You can also add projections as well.

Financial planning for private schoolFinancial planning for private school
Adding potential income and costs

The tool is excellent because it uses real expenses and income that have been tracked for however long you’ve been using the tool. Then the tool compiles the data and runs it through a Monte Carlo simulation to give you a numerical and graphical data of your future cash flow needs.

Below is an output example of the Retirement Planner that shows what will happen if this 41-year-old keeps on saving and investing based on his usual amounts and retires at age 50. The Retirement Planner says he has a 99% chance of retiring just fine because his projected cash flow is $18,416 a month versus his desired expenses of $12,500 a month.

Personal Capital Retirement Planner Free ToolPersonal Capital Retirement Planner Free Tool
Personal Capital’s Free Retirement Planner

Your goal is to get that percentage chance of having a great retirement to be above 95% while also being conservative in your income and expense forecasts. Sign up for free and see what the Retirement Planner spits out for you.

Readers, what retirement goals do you have before you retire? What safe withdrawal rate have you followed if you have already retired? Did you find some part-time work to give you purpose? Was it hard to withdraw funds? How did your retirement life turn out versus expectations?

Source: Reconciling Three Retirement Goals: 25X Expenses, 20X Income, 0.5% Withdrawal

What do you think?

Written by Financial Samurai

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