Using the Three Bucket Retirement Strategy

After many years of hard work and diligent saving for retirement, many struggle with the fear that they will outlive their nest egg. Or, perhaps worse, that the financial systems will collapse.

So what does one do? Plan!

It is my belief that the Three Bucket Retirement Strategy will both guard against adverse market conditions and grow your nest egg so that your money will outlast you.

Laying the Groundwork

Before the Three Bucket Retirement Strategy can be implemented, you will need to determine a number of factors to allow you to set up the buckets.

• How much will you need to have on an annual basis to do what you want to do?
• How much will you receive in Social Security/pension?
• How much will you be required to withdraw when you reach age 72, RMD (Required Mandatory Distributions)? An IRA, 401k, 403b or any retirement deferral account will require this. It does not matter if you need the money or not, you must take the money and pay the taxes. ROTH does not have this requirement.
• Determine what your tax liability will be. This needs to be added to your annual income needs. For example, if you want an additional $20,000 above your social security, the taxes you will need to pay are $10,000, so you will need a total of $30,000.

Setting Up the Strategy

Now that you have determined what your needs are, we can begin to set up the strategy. Let’s work with the following assumptions.

• Nest egg: $500,000
• Social security/pension: $30,000
• Desired annual amount you want to spend: $50,000
• Tax liability: $10,000
• Amount needed from Nest Egg: $30,000 (desired amount $50,000 plus tax liability $10,000 less social security/pension $30,000)

Bucket 1

This is the bucket referred to as the “now” bucket. The funds placed here would be for short-term use in the next two years. The rate of return will be small, if any at all. These funds would be kept in money market funds. Here, we would put in $60,000, based on our example. These funds need to be liquid.

Bucket 2

This bucket is the intermediate funds. Funds for the next five years would be placed in this bucket. The rate of return would be better than in Bucket 1. These funds would be placed in fixed-income type instruments. For example, treasury bonds, high-grade corporate bonds or perhaps a little more risky, dividend paying equities. These funds need to be semi-liquid, as this bucket will be used to replenish Bucket 1. Based upon our example, we would place $150,000 in this bucket.

Bucket 3

This bucket would be funded with the balance of your nest egg, this is the later bucket. For our example, it would be $290,000. These funds would be invested more for the long term. Since you have the first seven years of your retirement funded with Buckets 1 and 2, you can take on a little more risk, potentially using equities as an investment. Basically, mutual funds that have a solid track record could result in 10% or more in average annual return. Since the fear of market fluctuations is removed, this will allow for this type of targeted return. A 10% average return over seven years would double the size of this fund, bringing it to $580,000. This amount is larger than your original next egg.

Conclusion

As stated earlier, this is a possible strategy. I would not recommend that this is implemented unless you are comfortable with this plan. One important thing to keep in mind is that the world is not perfect and the actual results may be different from this example.

For instance, the market can increase in the first four years and then have a steep decline in year five, reducing the funds available in Bucket 3. It might not fully recover when you need some of the funds in year seven.

Another possibility is that your returns can be higher in the beginning and you may choose to move some from Bucket 3 to Bucket 2.

All in all, one needs to be diligent and understand how this is meant to work and what the risks are. This may not be for everyone. I, for one, think this is a viable strategy even with the associated risk.

Good luck with your retirement and may your funds outlast you! QCBN

By Steven Calabrese, CPA

Steven Calabrese, CPA, is the CFO of Polara Health. He also is the owner/operator of a website known as thebiweeklyadvisor.com, where topics such as budgeting, investing, paying off debt and goal setting are discussed.