In the decades leading up to retirement, your focus is on growing, growing, and growing your savings some more. But when it comes time to transition out of the workforce and into this next, exciting phase of life, your focus must shift from accumulating assets to determining the most effective way to draw them down. Your portfolio and other assets are, after all, what will fill your retirement “paycheck” over the coming years.
While there are several common methods for withdrawing in a sustainable way, we want to highlight one of the most popular (and relatively simple!) strategies used by retirees today.
The bucket strategy is a popular approach that leverages different time-based “buckets,” which helps those in retirement balance liquidity, growth potential, and risk. But is it the right withdrawal strategy for you?
Let's break down how the bucket strategy works, its potential benefits, and key considerations to keep in mind.
The bucket strategy is a retirement withdrawal strategy that essentially separates your existing assets into three buckets: immediate or near-term, mid-term, and long-term. Each bucket is used to fund a different segment of your retirement, and the assets held in the buckets have varying levels of risk and liquidity that reflect their anticipated timeline. As the timeline grows, the assets tend to be less liquid and more growth-oriented (we’ll dive into the specifics of each bucket in a moment).
You and your advisor can decide how long each bucket should last, though you may need to adapt your expectations as your retirement unfolds. Here’s an example of how your retirement withdrawal buckets could look:
While the bucket strategy commonly uses three buckets, you could always add more as needed to accommodate your specific needs or goals.
So you have three buckets that represent different periods of retirement. But how do they come together to create a sustainable withdrawal strategy?
As your near-term bucket gets emptied, since that’s where you'd withdraw on a day-to-day basis, you’d gradually transition assets from bucket 2 into it—essentially “refilling” the bucket. This is referred to as “bucket maintenance,” and there are plenty of opportunities to customize here based on your own financial needs and the current market environment.
Throughout your retirement, you’re meant to maintain your three buckets and (ideally) only pull from bucket 1 on a regular basis. As your portfolio evolves and your savings diminish, you’ll need to work strategically to replenish your first two buckets with the earnings and assets from bucket 3.
Now, let’s take a closer look at which assets generally belong within each bucket.
Your most liquid assets live here—think your checking and savings accounts, emergency fund, and cash reserves. It will likely also include any income that doesn’t draw down your portfolio, such as Social Security benefits, pension payments, or annuity payouts.
Depending on your age, required minimum distributions (RMDs) from your tax-deferred retirement accounts, including a 401(k) or traditional IRA, may live in this bucket as well.
You’ll use the funds in bucket 1 to cover your immediate financial obligations, typically over the next few years. The goal here is to preserve your other assets and allow them to grow (or, perhaps, recover if you’re experiencing market volatility). In an ideal world, you shouldn’t have to liquidate any assets outside of bucket 1 to meet your financial needs.
Keep in mind that asset allocation in retirement is a balancing act. You’ll want enough in your first bucket to cover your immediate expenses in retirement. You may also want to keep enough cash close by to cover anticipated big purchases or splurges (a child’s wedding, a family vacation, a new car, etc.) without having to pull from your long-term investments. At the same time, keeping too much of your wealth in cash exposes you to longevity risk since you’re missing out on opportunities for portfolio growth.
The second bucket is for assets you may need to access a little later, say, within three to seven years. This is where you’ll want to keep your short-term savings and more conservative investments.
Generally speaking, the assets in a mid-term or short-term bucket aren’t invested aggressively—rather, the goal is typically to keep pace with inflation and perhaps achieve modest returns (below what you’d expect of equities or other less conservative forms of investments). These assets will often include certificates of deposit (CDs), money market accounts, and short-term bonds, or other fixed-income securities.
Some people choose to use this second bucket as a way to save for bigger upcoming expenses or unexpected events, like hospital bills, college tuition for a child or grandchild, moving expenses, etc.
Your long-term bucket is where your most illiquid and least conservative investments will live, as they’re intended to be accessed last from your portfolio. The goal of the long-term bucket may be to support your late-in-life needs, such as long-term care or ongoing medical assistance. You may also want to use your long-term bucket to achieve your legacy goals, if leaving an inheritance to your children or grandchildren is a top priority.
This bucket will include stocks and perhaps any riskier or alternative investments you may have included in your portfolio. Volatile bonds (sometimes called “junk bonds”) may live in this category as well, since they offer less stability than higher-grade bonds (such as treasury bonds or municipal bonds).
The bucket strategy can help those in or near retirement replace concerns over “Will I have enough?” with a better understanding of where their money is coming from—and how sustainable their withdrawal strategy can be. Here are a few notable benefits of incorporating the bucket strategy into your retirement.
One of the major retirement risks is that a market downturn or major volatility could hit right as you begin drawing down your portfolio. Called sequence of returns risk, this refers to the direct correlation between poor market performance and portfolio longevity.
The younger you are when you retire, the longer you need your portfolio to last. If a market downturn occurs early on and you begin taking withdrawals, you aren’t giving it time to recover. This can impact the portfolio’s long-term performance and may risk its ability to support your financial needs throughout retirement.
But, let’s say you’re in the same situation—market downturn hits at the start of retirement—and you have a separate bucket of savings to live off of in the meantime. Now, you’re leaving your portfolio alone and giving it time to (ideally) recover in the coming months or years. Instead of withdrawing when it’s already experiencing poor performance, you’re preserving as much of your portfolio as you can. This is how the bucket strategy can help your portfolio last longer in retirement, even during periods of market volatility.
Believe it or not, some retirees have a hard time spending their money in retirement. No matter how much they’ve saved and planned for this phase of life, the thought of drawing down their funds can be nerve-wracking. Switching gears from accumulating assets to spending them is tougher than many people realize.
The bucket strategy is an effective way to boost a retiree’s confidence that there will, indeed, be money set aside for their anticipated future needs. While simply following this method without further budgeting or strategizing won’t guarantee total financial security for all of retirement, it can help some retirees overcome the mental hurdle of spending their savings a little too sparingly.
Now, if we swing the pendulum the other way, the bucket strategy can be an effective tool for combatting your urge to overspend as well.
When the majority of your retirement resources are pooled together, it can be more tempting to withdraw what you want, when you want, without much rhyme or reason.
The bucket strategy brings organization and purpose to each of your assets, giving you more digestible parameters for understanding how much you can access at certain points in your retirement.
The bucket strategy is common for retirees, and for good reason. Having easy access to cash that doesn’t interfere with your long-term investments can help keep more of your assets invested for longer—while still addressing your immediate and more mid-term needs.
If you’re considering the right withdrawal strategy for your retirement, you may find it helpful to speak with a financial professional ahead of time. They can help assess your existing resources, identify potential savings gaps, and map out a plan for withdrawing in a tax-efficient and sustainable manner.