Annuities and the Retirement Bucket Strategy

The bucket strategy is an increasingly popular way to invest in retirement. It entails segmenting your investing horizon into short-term, mid-term and long-term buckets and assigning investments to each bucket based on their risk characteristics.

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  • Written By
    Thomas J. Brock, CFA®, CPA

    Thomas J. Brock, CFA®, CPA

    Investment, Corporate Finance and Accounting Professional

    Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

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  • Edited By
    Lamia Chowdhury
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    Lamia Chowdhury

    Financial Editor

    Lamia Chowdhury is a financial editor at Lamia carries an extensive skillset in the content marketing field, and her work as a copywriter spans industries as diverse as finance, health care, travel and restaurants.

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  • Financially Reviewed By
    Brandon Renfro, Ph.D., CFP®, RICP®, EA
    Brandon Renfro, Ph.D., CFP®, RICP®, EA, expert contributor

    Brandon Renfro, Ph.D., CFP®, RICP®, EA

    Co-Owner of Belonging Wealth Management

    As a Certified Financial Planner™ professional and Retired Income Certified Professional®, Brandon Renfro is well-versed in the financial information and strategies needed to meet retirement goals. In addition to co-owning Belonging Wealth Management and assisting clients, Brandon writes regularly for financial publications.

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  • Updated: May 14, 2024
  • 8 min read time
  • This page features 6 Cited Research Articles

Key Takeaways

  • The retirement bucket strategy is an investment plan to optimize how people invest and drawdown on their funds, regardless of market conditions.
  • It allocates savings across three distinct time buckets, representing your short-term, mid-term and long-term spending needs.
  • The short-term bucket is for anything highly liquid but stable; the mid-term bucket is for high-quality, income-oriented investments; and the long-term bucket is for growth-oriented, high-volatility investments.

What Is the Bucket Strategy for Retirement Income?

The bucket strategy is an intuitive approach that simplifies and segments the investment process into easy-to-conceptualize time horizons, which are commonly referred to as buckets.

Investments are assigned to each bucket based on their risk characteristics. The result is a framework that enables an investor to simultaneously satisfy near-term liquidity needs, generate predictable income and ensure an appropriate degree of stability and growth potential.

This approach is similar to the Modern Portfolio Theory, which is a data-driven framework focused on constructing a portfolio in a way that offers either the highest possible return for a given level of risk or the lowest possible level of risk for a targeted level of return. While mathematically sound, many investors find this framework confusing and are reluctant to embrace it. Many others are unlikely to stick with it during turbulent times.

How To Use the Retirement Bucket Strategy

The foundation of the bucket strategy is your investment horizon, which is segmented into three distinct buckets – short-term, mid-term and long-term. Each is designed to hold assets that offer certain benefits and exhibit unique risk characteristics.

The short-term bucket should be filled with highly liquid, stable-value assets; capital preservation and accessibility are paramount. The mid-term bucket should house high-quality, income-oriented assets, and the long-term bucket is the place for relatively volatile, growth-oriented assets.

When structured appropriately, the bucket strategy gives you the flexibility to tap different buckets in different market environments. Ultimately, this enhances the resiliency of your portfolio and reduces your exposure to longevity risk. Generally, the most sensible drawdown tactics are as follows.

Common Drawdown Tactics

  • During down equity markets and periods of rapid inflation, the short-term bucket provides the most sensible source of liquidity.
  • During relatively stable, low-growth periods, tapping the mid-term bucket makes sense, enabling you to draw down on some of the income you’ve accumulated.
  • During expansionary equity markets, selling some of the appreciated assets in the long-term bucket is wise. The funds can be used to meet spending needs and replenish the mid-term and short-term buckets.

Short-Term Bucket

The short-term bucket represents the very near term, which spans anywhere from zero to two years. Anything you put into this bucket should be highly liquid and very stable. This money should not be exposed to any price fluctuations or liquidity lockups.

Generally, this means investing in cash and cash equivalents, which include U.S. Treasury bills, high-quality commercial paper and money market funds. High-yield savings accounts can be good short-term investment vehicles since the most competitive of which currently offers around 4% annual interest.

Mid-Term Bucket

The mid-term bucket represents a longer horizon, generally between two to 10 years. Investments put into this bucket should be relatively high quality, but much more income-oriented than the short-term bucket. Ideal assets for this yield-tilted bucket include long-term certificates of deposits, investment-grade U.S. bonds and annuities.

Long-Term Bucket

The long-term bucket represents a horizon of 10 years or more. It is designed to house growth-oriented assets that exhibit a lot of near-term volatility. The investments in this bucket may lose some value during down markets, but over the long term, they are the surest way to accumulate wealth and outpace inflation.

The most common growth-oriented assets include domestic stocks (large-, mid- and small-cap), international stocks (developed and emerging markets) and real estate investments. Ideally, these positions should be established through low-cost, diversified, fund-style vehicles, such as exchange-traded funds (ETFs), mutual funds and real estate investment trusts (REITs).

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Using Annuities To Bucket for Retirement

Annuities can be a great way to power the income-generating capacity of a mid-term bucket. The most appropriate products are deferred fixed annuities, however, deferred fixed index annuities can also be sensible.

The key is to make sure you do business with well-capitalized insurance companies that have a history of offering economical products with competitive crediting rates. If you do that, annuities can be a very efficient way to generate guaranteed income over the mid-term, as well as the long-term, if an “income for life” rider is desired.

Case Study Example

There is no hard-and-fast rule regarding how much money to put into each time bucket, but a plausible allocation scheme, along with a sensible assortment of assets, is outlined in the scenario below.

Let’s say Anna is a 65-year-old, single woman embarking on retirement. She has worked hard to accumulate $500,000 in a tax-advantaged retirement account and a Social Security benefit of approximately $1,800 per month.

That said, she does not have a good feel for how her money is invested, and she wants to conservatively plan for retirement without consideration for Social Security.

Ultimately, Anna wants to implement a transparent investment strategy that supports her spending needs and reduces her risk of running out of money. Her financial advisor has convinced her a bucket strategy is the way to go.

Anna, 65, case study infographic

To start the process, Anna and her advisor conservatively project an annual spending need of $50,000. This facilitates the determination of the target size for her short-term bucket. With a goal of having ready access to two years of spend, Anna puts $100,000 in a high-yield savings account.

This leaves $400,000 to invest over longer terms. Anna opts for a 50/50 split across the mid-term and long-term buckets, resulting in a $200,000 allocation to each. Anna’s preference to maintain hands-off, highly diversified and cost-conscious positions drives the rest of the implementation process.

For the mid-term bucket, she puts $100,0000 into a high-quality, passive bond fund that tracks the Bloomberg Barclays U.S. Aggregate Bond Index and $100,000 into a deferred fixed index annuity with a five-year accumulation period and a very competitive minimum guarantee.

For the long-term bucket, she puts $200,000 into a highly diversified all-world exchange-traded stock fund that tracks the FTSE Global All Cap Index, giving her exposure to large and small publicly-traded companies across all industrial sectors and geographic locations.

Following the implementation of the bucket strategy, ongoing monitoring and bucket-to-bucket rebalancing action is necessary.

Anna’s financial advisor helps her do this, shedding light on economic developments and offering advice on the best bucket to tap when funds are needed. The advisor also helps her right-size her buckets over time, moving money from overflowing buckets to deficient buckets, generally on a semi-annual or annual basis.

Benefits vs. Drawbacks of the Bucket Strategy

The primary benefits of the bucket strategy are its easy-to-understand nature and the flexible way it facilitates investing and ability for cash withdrawals, regardless of the market environment. The collective result is a balanced portfolio that helps retirees achieve a sustainable combination of liquidity, capital preservation, income generation and growth.

That said, the bucket strategy has some drawbacks. Most notably, it entails an ongoing monitoring and bucket-rebalancing effort, and it calls for the ability to make sense of different market environments. Additionally, as compared to more quantitatively focused investment plans, it tends to result in lower returns.

Fortunately, with the help of a skilled financial advisor, these disadvantages can be largely mitigated. Leveraging one entails a fee, but the long-term benefits are likely to outweigh the cost.

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Other Frequently Asked Questions About the Bucket Strategy

Do bucket investment strategies make sense in retirement?

Bucket investment strategies can be sensible at any stage of life, but they are especially popular with retirees. Mature investors tend to value their straightforward nature and the flexible, sustainable way they guide spending behavior.

What is the best strategy for fixed monthly income after retirement?

There’s no one-size-fits-all strategy for generating fixed income in retirement. Many hands-on and advisor-directed investors prefer holding a diversified portfolio of bond funds and income-focused stock funds to meet their income needs. Others value the hands-off, guaranteed nature of annuity products. Some embrace all the above.

How is the bucket strategy different from the 4% rule?

The retirement bucket strategy is an investment plan used by many people to guide their investing and drawdown behaviors. It entails establishing short-, mid- and long-term buckets and assigning investments to each segment based on their risk characteristics. The result is a flexible framework that enables you to safely spend money in a market-sensitive way. The 4% rule,  on the other hand, is an annual guideline for withdrawing money from your retirement account. It asserts you can withdraw 4% of your portfolio in the first year of retirement and adjust the percentage to account for inflation each subsequent year. In doing so, you can expect your savings to last for approximately 30 years.

How do I account for taxes with the bucket strategy?

The distributions taken via a bucket strategy are taxed based on the nature of the account where the assets are housed. For traditional 401(k) plans and individual retirement accounts (IRAs), all distributions are taxed as ordinary income. For Roth-style retirement accounts, the distributions are tax exempt. For regular brokerage accounts, earnings and realized capital gains on your investments are taxable in the year they are generated, whether reinvested or withdrawn. Distributions of your principal investments are not taxable.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: May 14, 2024
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