How Does the Retirement “Bucket Strategy” Affect Safe Withdrawal Rates?

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Early on in my post-MBA career, I started looking at how much we’d have to work to be able to retire early. I think that one of the reasons that I was able to pass the CFP(R) exam first time despite not having any sort of financial planning background was because I was a voracious reader of financial planning and advice articles, books, and forums long before taking the exam.

One of the earliest strategies I found for how to manage withdrawals in retirement was in an early retirement forum. The discussion was about the bucket strategy, which is an approach that was popularized by Harold Evensky, CFP(R), back in 1985.

A very recent article about personal finance during the coronavirus pandemic discussed how an 88 year old couple wasn’t worried about their finances because they were using the bucket strategy, and they were not forced to tap into equities too early after the market’s downturn.

It is unsurprising to me that the bucket strategy is popular with retirees. As we saw in “Will Annuities Make You Happier,” people who had their retirement savings invested in the market were less happy than those who had an equivalent net worth in pension payments or annuities because the swings of the stock market stressed them out.

We also saw in “Is It Possible to Have 100% Stock Asset Allocation in Retirement?” that it is possible to buy “insurance” for stock market drops, but such insurance is likely to be quite expensive, minimizing the estate that a retiree can leave behind.

But, as we saw in “Whoa, Whoa, Whoa…Aren’t You Overreacting to the COVID-19 Pandemic?” the most important thing for financial planning is to protect a very negative event from happening in your life. In the case of retirement planning, it’s running out of money before you run out of money. Nobody envisions gleefully going back to work as a Walmart greeter at age 85.

So, the retirement bucket strategy is meant to try to attain a happy medium between staying in the market to capture the usual upside and going all-in on annuities to ensure a constant stream of income in retirement.

What is the Retirement Bucket Strategy

Generally speaking, if you pursue the retirement bucket strategy, you’re putting your money into three investment categories:

  1. Cash. Some planners say one year’s worth of expenses. Some say three. For the purposes of this evaluation, I’m splitting down the middle and saying 2 years. That’s basically what we did when we retired.
  2. Income instruments. That’s financial planner speak for corporate bonds. Since you already have some of your net worth in cash, this number is typically lower than the usual asset allocation for safe withdrawal rate planning. For the puposes of this exercise, I assumed 25% of investable assets were invested in a corporate bond index.
  3. Equities. That’s financial planner speak for stocks. It’s 1 – percentage of investable assets in fixed income. I assumed an investment in the S&P 500 index for the purposes of this exercise.

If the market is down for the year, then you don’t withdraw to cover expenses from your investments. Instead, you take the money from the bucket, and then replenish it the next year. For this exercise, I assumed that you usually had to replenish the bucket slightly, as, generally speaking, inflation meant that spending went up from year to year. If the bucket was emptied, then, at the beginning of the next year, the retiree would withdraw enough to fill the bucket up to meet last year’s spending.

I also assume that retirees have a year’s worth of spending in cash at the beginning of the year, regardless of whether or not they use the bucket strategy. I’ve found that most of my clients were more comfortable with that strategy than doing more periodic withdrawals. They’d time it along with their asset allocation rebalancing.

As we saw in Revisiting SAFEMAX, withdrawing a year’s worth of expenses in the beginning of the year (or, even, monthly) method yields a slightly lower safe withdrawal rate than the historically quoted 4% safe withdrawal rate – and that’s before implementing the bucket strategy.

Unsuprisingly, research by Larry Swedroe (a highly regarded figure in the financial planning industry) showed that the bucket approach underperformed the historical SAFEMAX strategy. After all, a retiree who has 2 years of expenses in cash is not keeping that money in the market to take advantage of the average gain in the market.

But just how much should a potential retiree adjust his or her initial safe withdrawal rate to account for the perceived psychological advantages of a bucket strategy?

What is the Safe Withdrawal Rate for a Retiree Who Uses a 2 Years’ Expenses in Cash Bucket Strategy?

The adjustment in the SAFEMAX for someone who wants to pursue a bucket strategy in retirement is not much less than if the retirement strategy did not include buckets. This is because, generally speaking, the retiree is “starting” with roughly 96% of the investable assets that they should otherwise have to retire.

I did a simple backwards looking model to find out that maximum that a retiree could withdraw in the first year as a percentage of overall investable assets, along with a bucket approach, so that no retiree from 1928 to 1989 ran out of money in 30 years of retirement. The 1966 retiree barely skidded by!

Without a bucket strategy, as I outlined earlier, my calculated SAFEMAX was 3.87%.

However, with a bucket strategy, the same retiree could only have a SAFEMAX of 3.73%. In other words, you need to save 26.82 times annual spending before you retire if you plan on using the bucket strategy.

This is only 3.66% less initial spending than the retiree without a bucket strategy. So, a retiree who had $1,000,000 at retirement could start spending $37,289 per year and adjust for inflation versus a retiree without a bucket strategy, who could start spending $38,707 per year and adjust for inflation, or $118.17 per month less.

I know that, during the initial stages of the COVID-19 pandemic, we’ve been a lot less concerned about market swings because of our cash cushion. I personally value sleeping well at night over a handful of nights out at the restaurant per month (when we’re not quarantined).

What do you think? Would you reduce your spending by 3.7% in order to buy more time and feel a little less stress in retirement when the market swings wildly? Let’s talk about it in the comments below!

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Jason Hull was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. He held a CFP certification from 2015 - 2021. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

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