In previous installments we discussed systematic withdrawals and flooring, two approaches to building a retirement income plan for retirees. While both of those strategies can be very effective for producing income, each has drawbacks.
Notably, systematic withdrawals has a strong component of risk because of reliance on markets to deliver the returns necessary to derive desired income for decades. While flooring avoids the same risks of the market depleting assets, the risk of interest rates and early death present notable downside possibilities. Bucketing seeks to pair the best attributes of both strategies to offer a balanced approach to retirement income.
Bucketing (age-banded) can be defined as an approach to developing retirement income that segments retirement assets by category. While categories may be based on risk level of certain assets, the buckets can also be segmented by time periods designed to cover the life-span of the retiree. An example is a 3-bucket plan, with bucket 1 designed to cover years 1-5 of retirement, bucket 2 earmarked for years 6-10, and bucket 3 covering years 11+.
As a contrast to a probability-based approach, or total return, like systematic withdrawals, others will find great comfort in a safety-first approach to retirement income planning. Bucketing, like flooring, can provide substantial psychological benefits to retirees while simultaneously easing some practice-management burdens to advisors. By using age-based buckets in sequence, advisors can pair assets of increasing risk or guaranteed return with the time segment that best matches the chosen investment or product.
Offering pension-like income certainty, bucketing has the added benefit of breaking the long time horizon of retirement into smaller segments. For example, flooring presented the retiree with the risk of rising interest rates (if using a bond ladder) or premature death (if using a SPIA or single FIA or VA with an income rider). Bucketing allows you to utilize several smaller investment or product allocations in age-banded buckets. That way, if the markets change dramatically, the assets placed in the buckets can be adjusted to respond. It’s a form of diversification that also pairs products more closely with expected timeframes of use.
While there are a number of ways to fund the buckets, you can invest increasingly risky assets in each bucket. Or, you can build the entire income plan in a guaranteed manner by using 5-year payout annuities in the first two buckets, with a lifetime income rider product in the third bucket, allowing the strongest rollup of income benefits. If the client’s needs change, there is still flexibility available, while securing a guaranteed income stream much like flooring. If the client passes away before “turning on” all the buckets, any remaining account balances will pass to heirs, thus avoiding the premature death risk of flooring.
By pairing the income need with the income derived from the buckets, any remaining assets are freed-up from income generation duties and are able to remain at-risk for purposes of discretionary wants, inflation protection, long term care needs, and giving.
With these discretionary assets, the principles of prudent investing still apply, but the need for those assets to generate consistent income has been removed, thanks to the income generated by the buckets.
What are the downsides to bucketing? For one, the multi-bucket approach can be a bit more complex than a flooring model that uses a single source of income. Bucketing also requires a broader access to products in order to build it effectively.
Generally, no single carrier or manager will offer the most competitive options for all buckets. Bucketing tends to work best with a combination of guaranteed income products and risk-based investments, so dually-licensed advisors can have an advantage when building a bucketed plan.
With all of this in mind, for whom might a bucketing approach be suitable?
- Retirees who wish to transfer various risks such as: market, sequence of returns, frailty, and advisor risk
- Those who wish to maximize income predictability (as compared to a probability-based approach, which we covered in the systematic withdrawals discussion)
- Retirees who desire a balance between predictable income and asset flexibility
- People who are comfortable using insurance-based products and/or individual bonds to generate income
- Those who wish to have a complete income planning methodology that leverages the best attributes of each asset for its best use
While this discussion was never intended to be an exhaustive analysis of bucketing, I hope it inspires you to learn as much as possible before committing client assets to an income planning strategy. As another safety-first approach, bucketing offers a lot of flexibility for those families and advisors who wish to provide certainty and reliability of income.
In an era of ever-increasing complexity and retiree longevity, advisors face an unprecedented opportunity to add incredible value to the person who is approaching and entering retirement. In order to navigate the complexities of various approaches to building retirement income plans, we’ve laid the foundation for three distinct income designs: systematic withdrawals, flooring, and bucketing.
While we haven’t touched on every nuance of each strategy, we now have a foundation of knowledge from which to explore deeper study.
Now, more than ever, our clients need us to be agile, confident, and competent. May you continue learning, growing, and serving.