You need 25X your annual living expenses to be financially independent

A common question on everyone’s mind is: how much money do I actually need to be ready for retirement? How do I go about calculating that?

To do that, first you have to estimate your annual living expenses in retirement. There are a number of ways to do that. Some studies show that retirees typically spend around 70% of their income pre-retirement.

Or you can arrive at the number by comparing your current annual expenses to your expenses in retirement:

  • If you have a house will you still be paying mortgage or will you own the house outright
  • You will not have employer funded health insurance so you will have to go get your own which might increase your monthly expenses by a few hundred dollars
  • You will not have work related expenses like commuting or business attire
  • Will your kids be out of your house or will you still be supporting them, etc

Once you have calculated your annual expenses in retirement, there is a simple rule of thumb to give you an idea of how much your net worth needs to be in order to retire

Multiply your expected annual expenses by 25 .

Let’s see an example:

  • Let’s say your annual expenses are $40K
  • Multiply that number by 25. 40×25 = $1M This will give you a ballpark estimate of what you need to hit.

Now that you have a target FIRE number, you can start saving towards it!

Where does the 25X rule come from? Eagle eyed readers will notice that 25 is the inverse of the withdrawal rate in retirement: 4%

1/4% = 1/0.04 = 25

So the multiple needed is actually dependent on your safe withdrawal rate. If your safe withdrawal rate is 3.5%,

1/3.5% = 29 (approx)

i.e. with a 3.5% withdrawal rate, you will need 29 times your annual expenses