A Quick and Easy Way to Answer the Most Common Personal Finance Question. 

By J.R. Robinson, Financial Planner, May 2024

Saving for retirement is a ubiquitous financial planning objective for working Americans.  Most workers can expect to receive a portion of their retirement income from Social Security (or an equivalent state-sponsored retirement system for public employees in certain states).  Social Security typically replaces between 20% and 35% of worker’s wages when benefits.   

To maintain their standards of living after they stop working, most workers require other sources of income beyond Social Security.  While some may receive additional guaranteed income from former employer defined benefit pension plans, millions of working Americans will need to rely on their own liquid retirement savings to fund a large portion of their retirement income need.  This includes money accumulated in savings and investment accounts, Roth and Traditional IRAs, and employer retirement plans (e.g., 401(k),  403(b) 457(b), SEP, SIMPLE, etc.).

One of the most vexing problems people face as they approach retirement is how to determine whether they have saved enough.  In this article, I will review one common metric and  introduce one of my own invention – “The  Robinson Rule” – as a simple, back-of-the napkin formula to help you assess retirement preparedness.

The 25x Income Heuristic and the 4% Rule

Accumulating retirement savings equal to 25 times one’s current wages is a “magic number” that is often cited  in DIY investment forums, particularly those tied to the Financial Independence Retire Early (F.I.R.E.) movement.  I do not have any quibble with younger investors using that as a savings target, particularly, since a preponderance of Americans who are at or near retirement fall far short of that figure.  However, readers should be aware that this heuristic has some shortcomings.  

The 25X income figure is the amount at which a 4% withdrawal rate will equal your current wages.  For instance, if your annual wage is $100,000 today, 25 X $100,000 = $2.5 million.  4% of $2.5 million = $100,000.  Proponents of the this metric suggest workers can safely retire once their accumulated savings hits the 25X number.  The foundation for this metric is is the so-called “4% Rule” which many investors have misinterpreted to mean that a 4% inflation-adjusted withdrawal rate is sustainable for retirement at any age through any potential future investment environment.  

A fly in the ointment is that the original research used to produce the  4% sustainable withdrawal rate in the mid-1990s was based upon a 30-year withdrawal period for a 65 year-old investor.   Abundant subsequent research in the ensuing decades finds that the 4% rule should not be relied upon for longer periods and that there are realistic potential investment scenarios in which it might not even hold for periods of 25-30-years.  

NOTE:  While the original research contribution that introduced the 4% rule was extraordinarily valuable in raising investor awareness of sequence of returns risk and longevity risk, it is generally dismissed in academic research circles as a spending strategy as it leads sub-optimal spending in normal investment climates and may lead to premature depletion in extreme negative environments.

The Elegant Simplicity of Retirement Income Planning in the ‘80s and ‘90s

An alternative back-of-the-napkin method for people to quickly assess their retirement preparedness is to consider their current retirement savings (or the range of your projected savings at normal retirement age if you are farther from retirement ) and multiply it by the current interest rate on 1-5-year CDs or Treasuries.  For example, today  the attainable interest rate yield on 1-5 year certificates of deposit is 4.5%-5.5%.  Thus,  if you have $1,000,000 in retirement, the projected income estimate would be $1,000,000 X .05 = $50,000.  

The underlying principle behind this metric is simple – If you can live off the interest from your savings, you will never run out of money. This is paradigm is, of course, too simplistic for implementable planning because it does not account for the very real impact of inflation over time, and it assumes that interest rates remain fixed over time, which, of course they do not.  Nonetheless, when I began my planning career in the late 1980s and early 1990s, this was how retirement planning was done.  

As a common example, a person who was about to retire from General Electric (at the time, the largest employer in Pittsfield, MA where I began my career) would meet with me to plan the rollover of his/her GE Savings & Security 401(k) plan and inform me of his/her intention to invest as much of the portfolio as needed to meet their income needs in laddered CDs and allocate the rest  in stock mutual funds to help keep pace with the cost of living over time.  With CD yields at the time in the 8-10% range, this was a reasonable approach – one that did not require the sophisticated/complicated Monte Carlo simulation software to model or implement. 

There was no need for a 4% rule.  In fact, the guiding “empirical” formula of the day was that the maximum allocation to stocks for most retirees should be no more than100 minus your age.  With interest rates as high as they were from the late 1970s to the late 1990s, this seemed like a reasonable planning approach.  While stock market returns were still expected to exceed bond/cash returns over long periods of time, why put up with the volatility when you could get 8-10% risk-free (i.e., no volatility)?

However, as interest rates declined to the point where the income produced by CDs  was not sufficient to meet one’s living needs, the need arose for sophisticated simulation software that could base sustainability on spending strategies that require dipping into principle.   

What’s Old is Now New Again – “The Robinson Rule“

“Back in the day,” this is just how planning was done.  My clients did not need me to do projections or simulations.  Everyone knew how to plan for retirement spending.  A near universal retirement planning mantra of the time for the clients who were kind enough to hire me to be their financial advisor was “Live of the income and leave the principal to my heirs.” As long as interest rates stayed at those levels, they were not wrong. My role was just to help with  processing the rollover and implementing the investments.  

From the early 2000s through 2021, interest rates on 1-5 year CDs and treasuries fell to historic lows and hovered in the 0-3% range for nearly two decades, thus rendering the interest-only paradigm obsolete.  This time frame represents an entire generation and is long enough that the “Old School” income planning model has been forgotten by consumers and financial planners alike.  

When I first began my career, the income planning described above was so ubiquitous that it did not even have a name. With interest rates today holding steady in the more historically normal 4-6% range, I believe this metric may be worth reviving.  To give it a name, I have eponymously (and facetiously) coined it “The Robinson Rule,” but a better and more descriptive moniker might be the “Percent of a Million Rule.”  

These days, when someone asks, “Can I retire if I have $2 million saved for retirement?” I might respond by saying, “At today’s interest rate levels you can earn approximately $40,000-$50,000 in interest on $1 million.  With $2 million saved, is $80,000-$100,000 of income in addition to your social security benefit  at full retirement age (age 67) enough to maintain your standard of living?”  

Making Retirement Income Planning Tangible

It does not matter if the person has $500,000 or $5 million, this method is useful for making  the preparedness assessment tangible and quantifiable.  In my experience, even if people do not have a budget or an estimation of their living expenses in retirement, they do have a general sense of how much money they need to maintain their standards of living.

In my opinion, the “25x Income” and “Percent of a million Rules” are useful for giving consumers a general sense of whether or not they are on track for a secure retirement.  Neither is a substitute for more sophisticated dynamic accumulation and distribution planning that incorporates the income of tax, account types, asset allocations, variable returns, etc., but both are infinitely more useful benchmarks than having no plan at all. 

If you would like to take your retirement accumulation planning one step further, feel free to play with our proprietary Nest Egg Guru Retirement Savings app.  It allows you quickly and easily test different basic variables that are within your control (e.g., your savings rate, your investment allocation, your years until retirement, etc).  Based upon your inputs, the results will give you a realistic range of how much you will have at retirement.  We encourage you to focus on the bottom half of the simulation results so that you can see how much you may have if investment returns are normal, to below average to downright awful between now and when you expect to retire.  An example of how the output is presented is provided below:

Sample Nest Egg Guru Retirement Savings Simulation Results

John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru.