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May 06, 2015 at 11:01 AM
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.
