When financially planning for retirement, it is just as important to plan on how to efficiently distribute assets as it is to accumulate them. And while each individual’s retirement income plan is as unique as they are, there is one rule of thumb that can be applied to just about everyone: diversify, diversify, diversify.
An effective investor will develop a strategy that protects their income from market fluctuations and identifies the specific purpose for each investment they own. One such strategy is often referred to as the bucket approach. Here, four special designations are assigned to investments for various phases of retirement: Short-Term Income, Long-Term Income, Long-Term Growth, and Protection. This strategy allows a soon-to-be retiree to make purposeful investment decisions with confidence.
With the help of a trusted financial professional, an investor should consider future distributions, including Social Security and any available pension to tailor the following system, according to a recent article from PlanAdvisor.
The Short-Term Income Bucket
This bucket, which is often set up late in the accumulation phase, should include little, if any, risk. The goal of this bucket is to provide income for the first few years of the distribution phase. There are several options available here. Cash, laddering certificates of deposit, laddering individual bonds or laddering fixed annuities are all viable choices. Other options include a single premium immediate annuity, an indexed annuity with short-term payout periods, or a combination of these.
The Long-Term Income Bucket
In general, a little more risk should be taken in this bucket, which picks up where the Short-Term Income Bucket leaves off. Again, there are a number of investment choices here. Some are the same as in the Short-Term Income Bucket, but here one can also use annuities with income riders. These are structured like a pension, paying the individual an income stream in the future that cannot be outlived. These income riders also come in a variety of options. It is crucial that you are aware of exactly what you’re getting, the cost and restrictions when purchasing a rider.
The Long-Term Growth Bucket
The Long-Term Growth Bucket should be considered to have an open-ended investment horizon. This bucket should guard against inflation, unforeseen needs, or additional wants. All basic living expenses should be covered in the other buckets, so this bucket is meant to be truly liquid.
In general, it is suggested that the investor take an aggressive investment allocation within this bucket because the investment horizon is long and withdrawals will most likely be intermittent. Most investors will be comfortable with a more aggressive investment approach in this bucket since market downturns will not be felt as much. It is recommended that individuals diversify this bucket across all economic sectors based on market trends, reevaluating the investments monthly.
The Protection Bucket, which was not discussed in detail, can be used to protect against premature death, loss of Social Security income when the first spouse passes, and long-term health care expenses. Planning for these risks can get much more complex in planning, and unfortunately, some people just aren’t able to afford the mitigate these risks like they would like.
There are several variables that can affect the percentage of retirement assets devoted to each bucket, including income needs, coordination between nest egg distributions and other income sources, and assumed rates of return. It is important to recognize that there is no “one size fits all,” strategy.
Written by Rachel Summit