Do you know how much is your retirement income and where it comes from? Have you figured out if you have enough savings to cover your expenses in retirement?
When you’re in your 30’s or 40’s, the idea of retirement is far away. But when you’re in your 50’s and 60’s, the retirement is around the corner and not a theory anymore. You need to understand how much you will receive from Social Security or pension (if you’re a lucky one). You need to calculate the balances on your retirement accounts like 401(k), IRAs, Roth IRAs. Also, you need to figure out how much you will be able to withdraw each month.
When you retire and stop receiving a steady paycheck, you need to learn how to generate retirement income to pay for your expenses. Some of your income will come from Social Security, but the rest should come from your nest egg.
Recently I read a lot about the bucket strategy for retirement income. This strategy becomes popular and got discussed among many financial experts. With this strategy, you will divide your saved money between several buckets – investment portfolios. Each bucket or portfolio will be divided based on the time when you need money, asset allocation, and other goals.
The benefits of a bucket strategy:
The major benefit of the bucket strategy is simplicity.
I think dividing your savings into smaller portfolios or buckets with specific goals will help to manage them better than one big account. With the traditional 4% rule of thumb approach, you will generate retirement income by systematically withdrawing money from one big account.
You might lose money if you’re forced to sell your investments to get cash in the stock market downturn. But using the bucket strategy approach, you will keep some money in cash for the current expenses and leave the rest of them to grow for the future.
Here is the 3 buckets strategy to generate retirement income:
This bucket strategy plan is based on 3 different phases of retirement:
Bucket 1 – 1 to 5 years of retirement
The first 5 years of your retirement will be the most active. It’s often called “go-go” years.
Most of the time you’ll stay active, and you might be even still working part-time. People entering retirement today are more active and adventurous. In this phase, many retirees splurge themselves on exploring the world, buying a vacation home, a new car or even a boat.
Depending on where you currently live and the cost of living in your area, you might want to relocate to a warmer and sunnier place. The relocation usually comes with an additional coast of buying or renting, moving the furniture and belongings and renovating or upgrading the new place. The first 5 years of your retirement might be expensive, and you will need to have enough income to cover all additional expenses.
When you retire, you’ll likely spend more than you ever have before. The good advice is to hold back on big spending and stick to your budget. You don’t want quickly to blow through your savings like there is no tomorrow. The bucket strategy approach will help you to stick to your budget and provide income for those fun years.
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For example, you have accumulated $700,000 in savings and planning to retire in a couple of years. You figured out that you want to spend $5,000 a month ($60,000 a year) when you retire. Let’s assume that your combined guaranteed income from Social Security and/or pension is $3,330 a month ($40,000 a year).
Based on the calculations below you have an income gap of $1,670 a month ($20,000 a year) to cover your cost of living:
$5,000 – $3,330 = $1,670
Use the bucket strategy and put aside $100,000 to cover expenses and maintain your lifestyle for the first 5 years of retirement.
$20,000 x 5 years = $100,000
Bucket 1 is created to provide immediate income and cash for emergencies. You’ll want to fill this bucket with secure income sources like CDs (certificate of deposits), bonds, annuities, money market account, or just bank savings account. Keeping your savings away from higher-risk assets like stocks can help to insulate those savings from market downturns.
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Bucket 2 – 5 to 10 years of retirement
This bucket is for the middle retirement phase – between ages 70 and 80.
At this phase, you might slow down on your activities and will start spending less. Of course, you’ll still want purpose and fulfillment. But you might want to travel less or go on the less expensive trips to visit your friends and family.
You might find yourself more engaged in free activities like volunteering, gardening, taking classes at a local community center or spending time with grandkids. The most retirees will continue enjoying many different activities depending on their physical and mental state of health. And you will still need to have enough income to pay for your lifestyle and the cost of living.
The goal for this bucket is to produce income and preserve the capital. The bucket 2 is created to be tapped for income when bucket 1 runs out of money.
For example, you have accumulated $700,000 in savings and then allocated $100,000 for your first 5 years of retirement.
Then, divide the remaining $600,000 equally or in any numbers between buckets 2 and 3. I would put $350,000 in bucket 2 and $250,000 in bucket 3.
According to the theory behind the bucket approach, you’ll want to fill bucket 2 with income-producing investments like stocks with dividends, mutual funds, REITs, bonds, annuities.
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Bucket 3 – 10 to remaining years of retirement
The bucket 3 is for the late retirement years – 80 and older.
In your late years of retirement, you will spend less money on activities and travels, but more on healthcare. Unfortunately, medical spending tends to be higher in the last years of your life. Many retirees must move to an assisted living facility or a nursing home. Some can stay home and hire a home health aide. If you have long-term care insurance, it might help to pay a portion of nursing home or home health aide bills.
The goal for bucket 3 is long-term growth. Since you don’t need this money for 20 or more years, you could be more aggressive with your investment.
The money you put in this bucket should be invested in stocks and mutual funds. Although investing in assets like stocks is considered a risky investment, it’s still a good way to grow the money you don’t need for long time.
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There are some disadvantages of a bucket strategy:
- When you’re older, it will be difficult to maintain many accounts with different asset allocation
- It might be hard to keep the right amount of money in each bucket
- You need to self-manage your portfolios. If you’re going to use the bucket strategy you cannot adopt a set-it-and-forget-it attitude
The biggest concern is that you’ll spend your safest assets first. But when you’re older you end up holding a big chunk of your savings in high-risk investments.
Many baby boomers approach their retirement years. If you one of them, you might start thinking about how to manage your savings once you retire.
The expenses at each phase of retirement will depend on where you want to live, how you choose to spend your time, and how healthy you are.
You need to generate enough retirement income to fund your lifestyle, keep pace with inflation and protect your investments from market downturns. Your savings must cover your expenses for three decades and more.
The bucket system is designed to give you peace of mind. When you have money divided between “now, soon and later” investment portfolios, you don’t sell your shares when the market is in decline.
The best part of the bucket strategy is it helps to create a consistent income stream to last through your retirement years. It gives you more choice and flexibility where to draw your income from.
Share your thoughts about bucket strategy for retirement income.
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Disclosure: This information is only educational. I am not providing any specific financial advice or recommendations to any of my readers.
Great article! I haven’t heard about the bucket strategy approach for retirement income. It sounds like an interesting idea. What I like the most is the idea of investing some buckets with more risk and other buckets left filled with conservative investments or cash.
Thank you for reading and sharing your thoughts on the topic. Like any financial strategy, the bucket strategy has its own pros and cons. But I believe it could be a great approach for generating income in retirement.
John B. says
Smart idea of dividing your retirement savings based on different phases of life in retirement. It was very helpful to see the whole idea in numbers.
Happy to know that you found this post helpful.
Great post! Thanks for sharing your thoughts and ideas on the topic. It made me think that I should start working on my own bucket strategy or at least to put all numbers on a piece of paper.
Glad to know that you found this post helpful.
Joe Davis says
You are the only one besides Ray Lucia who advocates 5 years for bucket one instead of two years to withstand a market downfall.
Hi Joe, thank you for sharing your thoughts on the bucket strategy. As any financial strategy it has it’s own pros and cons. The bucket #1 is for 1 to 5 years. Everyone who wants to use this strategy will play it differently. I personally would love to have enough cash and liquid assets to fund the first 5 years of our retirement with other buckets containing riskier investments. Having enough cash available will give me a peace of mind knowing that I don’t need to sell any other investments in down market to pay for our retirement expenses.
Kumar A says
When to fill bucket-1 after 1 or 2 year ? or wait till 5 years ?
Bucket-1 to be filled by bucket-2 or bucket-3 or from both ?
These are basic queries not cleared usually in the article by the authors. Kindly clarify in details, as it is the most difficult thing to manage in bucket strategy.
I am not a financial advisor, so I cannot recommend how to apply the 3 bucket strategy to your financial situation. As for myself, I like the idea of keeping one to three years in cash and maybe three to five years of my portfolio in bonds to cover living expenses. This way if the market crashes I will have enough money to cover retirement expenses for a long time without being forced to sell the stocks at the reduced price.
Kumar A says
Sorry, by mistake I addressed to Joe instead of you Maggie.
Thanks for your great article. I’m 2 years from 55 and a pension and am deciding on the best way to start filling bucket 1 – which needs to to be 4x my current emergency fund. Selling stocks to move to cash will trigger taxes and seems unwise. Is it best to stop contributing to Roth and 403b accounts and direct all available resource toward cash? Or keep investing as usual? So hard to quit investing in equities…
Hi David. Yes, you are right. If you start selling stocks it will bump you into higher income tax bracket. Which is not wise if you are still working and earning income. I think you should continue contributing to Roth and 403b because these retirement accounts have so many benefits. You can use Roth as cash withdrawals but you need to check if you won’t be penalized for early withdrawals.
I am not a financial advisor and I don’t know your overall financial situation so I cannot give you any recommendations. I am personally planning to create different buckets after we downsize and sell our house. So it will be easier to move money around, create buckets and leave our 401k, IRA and Roth to continue to grow for a while.