A buckets approach to retirement income: One of the most common questions financial planners receive from pre-retirees is, “What’s the safest way to give myself a paycheck once I quit working?”
Those who have been around long enough probably know someone who retired close to a particularly bad market year, like 2001, 2007 or 2008. Because that someone had to, or chose to, sell some investments at that terrible time, they ended up living off of much less than they originally thought. This can be a scary thing to watch. It makes some wonder, “How do I make sure that doesn’t happen to me?”
The Buckets Approach
Enter the buckets approach to retirement income. Below is a link to a video excerpt from the online course, “Retirement Readiness,” outlining a buckets approach in more detail. (A link to the course can be found at the bottom of this article and here.) A description for each of the buckets follows below.
Bucket 1 – Cash and Money Market Accounts
The first bucket will provide your paycheck. The rule of thumb is to
1) calculate any retirement income you will have (pension, Social Security, dividends, interest, rental property, for examples);
2) figure your annual recurring expenses (do not include one-time expenses such as replacing a car, roof, or paying for a special trip or wedding);
3) subtract 2) from 1); and
4) keep 1 to 2 years of that difference in Bucket 1.
For example, Justine retires at 65. She expects to live past age 82 so she is waiting until 70 to claim Social Security. She has a pension of $800/month. Her recurring expenses are $70,000 annually. The annual difference is $70,000 – $9,600 = $60,400. To start retirement, she decides to keep 1.5 years of the difference in Bucket 1 so $60,400 x 1.5 = $90,600. She puts that in a high-yield money market account and sets up an automatic transfer of $5833.33 monthly to her checking account. Voila – she has a new paycheck.
When she turns 70, she will collect $45,000 in Social Security. At that time the annual difference will fall to $70,000 – ($9,600 + $45,000) = $15,400. She decides to keep 2 years of the new difference in Bucket 1, so $15,400 x 2 = $30,800. She reduces the monthly transfer from the money market to $1283.33 per month.
Bucket 2 – Bonds, CDs, and Bond Funds
The second bucket replenishes Bucket 1. As the paychecks come out, the principal in the money market account will naturally decrease. When the balance reaches a level you have predetermined, a transfer is made from Bucket 2.
Bucket 2 is comprised of a combination of CDs, bonds, and or bond funds. CDs and bonds have maturity dates, so they are structured in a ladder (staggered maturity dates usually 6 to 12 months apart into the future). As each one in the ladder matures, the principal is either transferred to Bucket 1, or redeployed into a new CD or bond with a maturity date at the end of the ladder. If bond funds are used, they are laddered according to the duration in the fund, and the funds are sold as needed to replenish Bucket 1.
Bucket 3 – Stocks and Stock Funds
Bucket 3 replenishes Bucket 2 through harvesting gains in stocks. To do so, the general rule of thumb is:
- Review Bucket 3 on a regular but infrequent schedule (at most quarterly and at least annually). I
- f there are gains, transfer those to replenish Bucket 2.
- If there are no gains (i.e. the market is in a correction), then do nothing until the next scheduled review.
In this way, stocks are not sold at the most inopportune time. With up to 5 years of paychecks in hand, the first two buckets provide a secure cushion from market corrections.
Final Notes
It’s worth noting that whether the buckets are held in a tax-deferred account or a taxable account makes a difference. Buckets may be spread across accounts in different combinations to minimize taxes.
The goal of the Bucket approach isn’t to generate the best returns of any retirement portfolio on record, but rather to help prevent retirees and pre-retirees from selling at an inopportune time. Thus, a new retiree could use the bucket concept to replace their paycheck without worry about what markets are doing that month.
For a short online course on how to speak “finance” about retirement readiness, see Simple Finance Retirement Readiness: https://bit.ly/3p3BkXE.
