Bucket Strategies for Retirement Income

A bucket strategy divides your retirement portfolio into separate segments based on when you'll need the money. This approach helps you avoid selling stocks during market downturns while maintaining reliable income throughout retirement.

Why Use a Bucket Strategy?

Sequence-of-returns risk poses a significant threat to retirees. If you experience poor market returns early in retirement while withdrawing funds, your portfolio may not recover even when markets improve later. A bucket strategy addresses this by keeping several years of expenses in stable, low-volatility investments.

The core principle: match your investment time horizon to each portion of your spending needs. Money you need soon stays safe. Money you won't need for years can remain invested for growth.

The Three-Bucket Framework

Bucket 1: Cash and Short-Term (1-2 Years of Expenses)

Purpose: Cover immediate spending needs without market exposure.

Appropriate investments:

• High-yield savings accounts
• Money market funds
• Short-term Treasury bills
• Certificates of deposit (CDs) maturing within 1 year

Target amount: 1 to 2 years of annual expenses after accounting for guaranteed income sources like Social Security or pensions.

Bucket 2: Bonds and Intermediate-Term (3-7 Years of Expenses)

Purpose: Provide growth above inflation while maintaining relative stability. This bucket refills Bucket 1 during normal market conditions.

Appropriate investments:

• Intermediate-term bond funds
• Treasury Inflation-Protected Securities (TIPS)
• Investment-grade corporate bonds
• Bond ladder with 2-7 year maturities

Target amount: 3 to 5 years of annual expenses.

Bucket 3: Stocks and Growth (8+ Years)

Purpose: Maintain long-term purchasing power and portfolio growth. This is the engine that replenishes Buckets 1 and 2 over time.

Appropriate investments:

• Diversified stock index funds
• Dividend-paying stocks
• Real estate investment trusts (REITs)
• International equity funds

Target amount: Remaining portfolio assets.

Refill Rules: Keeping the Buckets Balanced

Annual Rebalancing Approach

At the end of each year, review your bucket allocations and refill as needed:

1. Calculate how much you spent from Bucket 1 during the year
2. If Bucket 3 has gained value, sell enough to refill Bucket 2
3. Transfer from Bucket 2 to bring Bucket 1 back to target
4. Document all transfers for tax planning purposes

Opportunistic Refill Approach

Rather than following a strict calendar, refill buckets when market conditions are favorable:

• After a strong stock market year (gains over 15%), take extra profits to extend Bucket 1 and 2
• During market downturns, pause refilling from Bucket 3 and let Buckets 1 and 2 cover expenses
• When interest rates rise significantly, consider extending bond duration in Bucket 2

Hybrid Approach

Many retirees combine both methods:

• Minimum annual refill to maintain at least 1 year in Bucket 1
• Additional opportunistic refills when stocks perform well
• Flexibility to pause during severe downturns

Worked Example: $1.5 Million Portfolio with $60,000 Annual Spending

Initial Setup

Margaret, age 65, retires with a $1,500,000 portfolio. She receives $24,000 annually from Social Security, leaving a $60,000 gap her portfolio must cover.

Step 1: Calculate bucket targets

Step 2: Determine asset allocation

Year 1: Normal Market Conditions

Market performance: Stocks return 8%, bonds return 4%

Refill action: Transfer $55,200 from Bucket 3 to Bucket 1, restoring it to $120,000.

Year 2: Market Downturn

Market performance: Stocks decline 20%, bonds return 2%

Refill action: Do NOT sell stocks at depressed prices. Instead, transfer $55,200 from Bucket 2 to Bucket 1.

New balances after refill:

• Bucket 1: $120,000
• Bucket 2: $263,040
• Bucket 3: $888,960

Margaret still has over 4 years of expenses in Bucket 2, providing time for stocks to recover.

Year 3: Market Recovery

Market performance: Stocks return 25%, bonds return 5%

Refill action: Stocks have recovered significantly. Sell $79,008 from Bucket 3:

• $55,200 to refill Bucket 1 to $120,000
• $23,808 to restore Bucket 2 to $300,000

Tax Considerations for Bucket Management

When refilling buckets, consider the tax implications of each transfer:

Strategy: During years when you have lower income, consider refilling from tax-deferred accounts. In higher-income years, draw from Roth or sell investments with minimal gains.

Common Bucket Strategy Mistakes

Mistake 1: Keeping too much in Bucket 1. While safety feels comfortable, excessive cash holdings reduce long-term growth potential.

Mistake 2: Strict adherence to calendar rebalancing during market crashes. The bucket strategy works best when you have flexibility to pause stock sales during downturns.

Mistake 3: Ignoring bucket refills during strong markets. Take advantage of good years to extend your safety buffer.

Mistake 4: Not accounting for Social Security, pensions, or other guaranteed income when sizing buckets.

Bucket Strategy Implementation Checklist

• Calculate your annual spending gap after Social Security and any pension income
• Determine your Bucket 1 target (1-2 years of the spending gap)
• Determine your Bucket 2 target (3-5 years of the spending gap)
• Allocate remaining assets to Bucket 3
• Choose appropriate investments for each bucket
• Set up automatic monthly transfers from Bucket 1 to your checking account
• Schedule an annual review date to assess bucket levels
• Document your refill rules (annual, opportunistic, or hybrid)
• Consider tax implications of which accounts to draw from
• Review and adjust bucket sizes every 3-5 years as spending patterns change