One of the key strategic decisions advisors who work with retiring clients face is whether to use systematic withdrawals or the “bucket” approach to serve investors transitioning from asset accumulation during their working years to income distribution during retirement.
While these are not the only strategies, they are the two most popular and the debate over these two retirement income strategies is a fixture at financial advisor conferences.
To help advisors understand the trade-offs, the Principal Financial Group has released a new white paper that explores the relative merits of these two approaches. The paper, which assumes a generally neutral stance, walks advisors through both the advantages and shortcomings of both approaches.
There are different kinds of bucket approaches, but the white paper is based on the most popular approach, which allocates client assets according to early, later and more distant phases of retirement. For the earliest phase (which could be, say, three or five, years), advisors would set aside a “bucket” that will meet the client’s income needs through cash and cash equivalents; for a middle phase that might extend from, say, five to 15 years, advisors would set aside a portion of fund that are invested in fixed-income securities; and the third bucket, designed to meet needs for 15 or more years away, advisors will allocate equity investments that exhibit greater volatility but which may generate greater returns.
The bucket approach offers the client a greater feeling of self-control. “For retirees feeling overwhelmed by the many decisions they face as they enter retirement, a bucket strategy may help them divide what they see as one large, stress-inducing problem into smaller, more manageable pieces,” the analysis states.
In contrast, systematic withdrawals involve taking a pre-determined withdrawal amount, say 4% or 5% of the portfolio, with the whole portfolio subject to greater or lesser volatility depending on how aggressively or conservatively the portfolio is invested. Based on the use of target-date funds with shifting asset allocations (the paper details its underlying investment assumptions), the systematic withdrawal approach typically offers a higher degree of income sustainability.
“While the investor may feel more secure with money segmented and designated for future use, the strategy may not provide financial benefits beyond what may be accomplished with a less complicated strategy,” the analysis concludes (though it suggests ways to tweak the buckets to narrow the differences).
The bottom line, according to the Principal Financial Group’s analysis, is that the bucket approach offers psychological advantages to the client and exacts greater effort from the advisor–but these are factors which can strengthen the advisor-client relationship by requiring more frequent check-ups, for example. The systematic withdrawal approach, meanwhile, is simpler to implement and typically generates superior financial results, factors that may account for its wider adoption by advisors.
An FPA survey of its membership reveals that 50% follow the systematic withdrawal strategy and 28% the time-segmentation bucket approach.