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Retirement Income: Designing A Financial Plan to Create Consistent Income Thumbnail

Retirement Income: Designing A Financial Plan to Create Consistent Income

In the face of ever expanding life expectancies and rising retirement costs, planning for lifetime income sufficiency is more daunting than ever. Retirees must be able to come up with an optimal spend-down plan that protects them from prolonged market declines while maintaining the lifetime income value of their assets for as many as 30 years or more. Financial advisors have relied on different rules and models to forecast cash flow and spend down rates under various circumstances and, as is true of any rule or model, they aren’t without flaws. In period of low interest rates and the potential for extreme market volatility, retirees are in need of an income strategy that can provide more certainty in creating a stream of income they won’t outlive.

The Traditional Spend Down Strategy

For several decades, financial advisors have been applying the “4 percent rule” based on historical averages that imply retirees can confidently spend down their assets at a rate of 4 percent per year without risking the complete depletion of their assets. However, today’s retirees are discovering that rules based on decades old historical averages don’t reflect 21st Century realities – including rising health and long-term care costs. 

Financial advisors have been adjusting the rule to account for higher retirement costs and greater volatility, offering up a 3% version and then adjusting it along the way based on changing circumstances. It can get complicated and, for retirees, create uncertainty. That’s why an increasing number of advisors are turning to the “bucket strategy” as a more tried and true alternative.

What Exactly is the Bucket Strategy?

The Bucket Strategy is a straightforward approach that I like to use with clients when we are generating their retirement income. Simply, it is retirement portfolio planning for generating income to meet cash flow needs while maintaining a diversified investment portfolio of stocks and bonds. At its core is dividing your assets into three buckets – a cash bucket that will provide up three to five years of living expenses; an intermediate term bucket earmarked for income in year’s four to nine; and a long-term bucket used to grow assets for income 10+ years out. The strategy can be broken down into more buckets if it makes it easier to manage.

Simplifying Income Planning

The concept simplifies income planning by compartmentalizing current and future retirement income into the three buckets (portfolios), each with a specific time horizon and an asset allocation designed for a specific objective. For example, the first bucket is filled with cash and cash equivalents for meeting current expenses and emergencies. The second bucket might be invested in short- to intermediate-term bonds to allow to generate a higher return. The third bucket is your growth portfolio allocated among stocks and bonds for growing your lifetime income value. 

This can be less overwhelming than having to manage one big portfolio, especially during turbulent times. For example, if you had retired in 2008 utilizing the four percent rule, you would have taken withdrawals from one overall portfolio during a very weak market. However, with the bucket approach, your cash needs for the first few years are already set aside, so you wouldn’t need to sell stocks at the worst possible time. The bucket containing a stock portfolio is earmarked for income 10 or more years out, giving it plenty of time to roll through the market cycles.

Perpetual Buckets

Once the initial strategy is implemented, the buckets are exchanged as they are used. For example, after the first five years, a new bucket #1 is created by shifting assets from bucket #2; and additional assets are shifted to bucket #2 from bucket #3. The amount allocated to each bucket depends on your new time horizons and investment objectives. This doesn’t have to be done after five years as it can be done incrementally year after year, or more aggressively when markets are up (and vice versa).

With more than 10,000 baby boomers crossing the retirement threshold each day, the need for retirement income planning is paramount. Today’s retirees are looking for simple solutions and greater certainty in their planning. By assigning specific asset buckets to the different time horizons and income needs, it become much easier to manage risks while creating a more reliable income stream that you won’t outlive.