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The retirement bucket strategy is a retirement income plan that breaks your nest egg into three buckets: short-term needs, mid-term needs and long-term needs. Each one is filled with different assets with varying levels of risk. (Higher-risk assets go in the long-term bucket, while safer assets go in the short-term one.) This way your income needs are always met, regardless of market volatility.
It can be an attractive approach for retirees, but the retirement bucket strategy does have its drawbacks. Here's a closer look at how it's used so you can decide if it's a good method for you.
What Is the Bucket Strategy for Retirement Income?
If you're relying on your nest egg to provide income for decades, you'll want to be strategic about how you manage your assets. Market volatility in the short term could majorly disrupt your financial health if the bulk of your money is tied up in investment accounts: You could be stuck selling investments at a loss to cover your immediate income needs, which is less than ideal for retirees.
The retirement bucket strategy is meant to insulate you from market ups and downs. It divides your assets into three "buckets" based on when you'll need the money. Short-term income needs are typically funded with a combination of safe investments, cash reserves and other assets that are less affected by market swings.
Meanwhile, intermediate needs are funded with medium-risk assets. High-risk investments are earmarked for long-term needs. That gives this bucket time to rebound from market slumps and generate the best possible returns.
How Do Taxes Work With the Bucket Strategy?
When it comes to taxes, your obligation will depend on the type of account from which you draw funds. Distributions from tax-deferred accounts like 401(k)s and traditional IRAs are taxed as ordinary income. Contributions you make to accounts that are funded with after-tax dollars, like a regular brokerage account or money market account, are not taxed—though you'll likely be taxed on earnings like investment gains, interest and stock dividends during the tax year they're realized. An unexpected tax bill can be an unwelcome surprise in retirement, so it's wise to strategize your income withdrawals.
How Does the Retirement Bucket Strategy Work?
In practice, the bucket strategy is built around your unique income needs. It begins by estimating how much money you'll spend per year in retirement. That includes expenses like:
- Housing and utilities
- Debt payments
- Health care expenses
- Charitable giving and gift giving
Once you have a ballpark idea of your annual spending, that number will be your guide for filling your retirement buckets.
The Short-Term Bucket
This bucket is meant to provide two years' worth of retirement income. If you have any guaranteed income sources, you can factor those in here. This includes Social Security benefits, pensions, annuities and any cash value you may have in a permanent life insurance policy.
From there, this bucket is funded with low-risk assets. They're unlikely to yield meaningful returns, but their reliability is what counts. The following income sources fall into this category:
The short-term bucket is all about liquidity and should allow you to meet your income needs without worrying about what's going on in the market. When this bucket begins running low, the idea is to replenish it with investment returns, dividends and interest income from your other two buckets.
The Intermediate Bucket
This bucket is dedicated to income you'll need three to seven years from now. Its function is to create both income and stability. The risk level here is medium. Playing it too safe can make it difficult to keep pace with inflation; being too risky could result in losses that impact your ability to meet your income needs. Ideal assets include:
- Longer-term bonds
- Real estate investment trusts
- Growth and income funds, which are a type of exchange-traded fund or mutual fund that's built for growth but also generates interest payments or dividends to provide income
- Preferred stocks, which typically pay out fixed dividends that are distributed ahead of investors who hold common stocks
Returns generated from this bucket can be used to replenish your short-term bucket as needed.
The Long-Term Bucket
Devoted to growth, this bucket is earmarked for high-risk investments that will help you beat inflation over the long haul. That describes volatile assets that are likely to go up and down in value during the short term—but hopefully net meaningful returns over the next decade and beyond. This includes:
- Individual stocks
- Real estate
- Private equity funds
- Peer-to-peer lending
- Hedge funds
- Angel investing
- IPO investing
- Venture capital investing
As income is generated from these investments, retirees can top off their intermediate bucket.
Benefits of the Bucket Strategy
- It protects retirees against market volatility. Short-term income needs are met with safer investments. That can give retirees peace of mind that market fluctuations won't affect their day-to-day cash flow.
- It leaves room for growth. Inflation is top of mind these days, but retirees may be nervous about investing in high-risk investments to keep up. The retirement bucket strategy carves out space in your portfolio for growth while protecting your immediate income needs.
- It organizes your portfolio. Most nest eggs have a lot of moving parts. Organizing your portfolio this way can make it feel more digestible for retirees. As one bucket is depleted, they can simply reach for the next one to refill it.
Drawbacks of the Bucket Strategy
- You must have sufficient assets. When you estimate your total annual expenses, you might find your retirement fund stretched thin. That can make it difficult to adequately fund each bucket. You may need to reduce your spending or adjust your retirement expectations to make the numbers work.
- It may not align with your investment style. Some investors might prefer to live larger in early retirement and spend less later on—or vice versa. Others may want to invest more in high-risk stocks, or play it extra safe. The retirement bucket strategy might require more work to reflect your investment style and risk tolerance.
- You'll need to rebalance as needed. While the bucket strategy provides a road map for retirement income, the actual assets you choose for each bucket are entirely up to you. You'll still need to choose an appropriate asset allocation and rebalance accordingly to keep your buckets in line. Otherwise, your portfolio could become lopsided with regular market activity.
The Bottom Line
The retirement bucket strategy is one way to manage your income when you're no longer working. If the style resonates with you, it can provide stability and allow you to grow your portfolio during retirement. Rebalancing your portfolio at least once a year is recommended.
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