Managing retirement income with a bucket strategy

A bucket strategy aims to help balance the need for ongoing income and capital growth throughout retirement by establishing and maintaining different pools of savings, each with their own purpose. The aim is to generate good capital growth while reducing the risk of having to sell investments when the market is down.

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There are many variations, but a typical option is to create three buckets.

How does the strategy work?

The bucket approach splits your retirement into phases, and appropriate investments must be selected to finance each phase. These varying investments are all held within a single account-based pension.

In our three-bucket example, your retirement savings would be divided into:

1. The short-term bucket

This is the liquid component of your retirement savings, from which all pension payments are drawn. It is invested in stable assets such as cash that can be accessed immediately or at short notice. This portion is not designed to grow, but rather to give you peace of mind that the next few years’ income is available and not subject to market fluctuations.

2. The medium-term bucket

The second bucket is intended to balance the need for stability with the potential for some capital growth in the medium term. Positive investment returns from this bucket are used to top up the short-term bucket. Typically 30–50% of this bucket would be invested in growth assets such as shares and property, with the remainder in more stable income-producing assets such as bonds and cash. The appropriate allocation depends on your attitude to investment risk and your goals and may fall outside the usual range.

3. The long-term bucket

The third bucket is for long-term capital growth, reducing the risk your retirement savings will run out. It is invested mainly in growth assets and will fluctuate more in the short term but should generate higher returns than the other buckets in the long run.

Positive returns from this bucket can be used to top up the short-term bucket. If the market declines, assets from this bucket are ideally not sold, but are held for the longer-term to ride out market volatility.

Bucket maintenance and repair

Once the strategy has been established, it must be maintained. Some super funds offer a bucket strategy investment option that will do this maintenance for you based on pre-established rules. We’ve provided links at the end of this article to those we have found.

Maintenance involves adjusting the buckets periodically, usually annually or every six months, with the cash bucket being topped up from returns generated in the other buckets. This is sometimes called ‘rebalancing’.

When market declines cause a fall in value in one or both growth buckets, the rebalancing process may be postponed entirely or restricted to moving assets only from a bucket that has experienced growth into the short-term bucket, leaving any assets that have declined in value untouched. Income can continue to be withdrawn from the remaining cash, with complete rebalancing postponed until the value of the other buckets recovers from the market decline.

Keep in mind that in the case of a serious downturn there may not be time for the medium- and long-term buckets to fully recover before the balance of the short-term bucket runs out. The bucket strategy reduces the chance you will need to sell assets that have declined in value but cannot eliminate it completely.

Case study

Sita retired at 65 and started an account-based pension on 1 July 2018 with a balance of $620,000. She decided to withdraw income of $37,000 per year to combine with her husband’s retirement income.

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Sita invested her account balance as follows:

Year 1

After one year, Sita checked the balance in her investment options and rebalanced her buckets. Her target was to top up her short-term bucket for three years’ income and to split the remaining balance equally across her other two buckets as shown below:

Note that Sita’s total balance after one year is higher than her starting balance, despite her $37,000 of income withdrawals. In this example, Sita experienced strong investment returns during 2019. After rebalancing she has moved some earnings from both her medium-term and long-term buckets into her short-term bucket.

Year 2

The table below shows Sita’s situation after the second year. The balances of her medium-term and long-term buckets have not grown very much because of the market crash that occurred during the COVID pandemic. Sita decides not to do any rebalancing this year because she feels secure in having at least another two years of income ready in her short-term bucket and hopes her other buckets will perform better next year.

Year 3

After a further year, returns have recovered strongly, and Sita decides to rebalance her account using the same rules as year one – returning her short-term bucket to three years of income and splitting her remaining balance evenly in the other buckets.

Year 4

In the fourth year, returns in the medium- and long-term buckets have been negative. Sita again decides to hold off rebalancing her buckets to avoid selling assets after a loss. Her situation is shown below.

Year 5

In the fifth year, Sita’s returns in the medium and long-term buckets have been good and the balance in both is higher than in June 2021 when she last rebalanced. She decides to again place three years of income in the short-term bucket.

Who could benefit from a bucket strategy?

The bucket strategy is most suitable for people who have a balance of $200,000 or more and will be using an account-based pension to provide retirement income for the long term. For those with a smaller balance, the bucket strategy can still be useful if pension payments are correspondingly small and there are no plans to withdraw lump sums.

If you’re a person who is likely to feel tempted to switch to cash out of fear when your investments suffer a capital loss, the bucket strategy has a positive role to play. The knowledge that you have a cash reserve and a strategy to cope with market fluctuations will give you increased confidence and help you avoid the trap of locking in your losses.

Drawbacks to a bucket strategy

Despite its attractions, a bucket strategy may not suit everyone. Some issues to keep in mind are:

1. Complexity – Setting up and maintaining the strategy can be difficult. Decisions must be made about how many buckets to maintain, how much to invest in each, and the asset allocation (investment choice) that should apply to each bucket. Rules for maintenance need to be chosen and followed regularly. Personalised financial advice or a pre-made bucket strategy investment option from a public super fund could help.
2. Potentially unsuitable for conservative investors – Returns from the short-term (cash) bucket will be low. For the strategy to be effective, the longer-term buckets must contain significant exposure to riskier growth assets. For conservative investors, this may be uncomfortable. More financial education or advice from a trusted professional could help overcome this, as the cash reserve in the short-term bucket does provide a buffer from negative returns.
3. Compatibility with a transition-to-retirement (TTR) strategy – If you are drawing income from a TTR pension and salary sacrificing back into super the bucket strategy is not necessary. The income withdrawn from your pension is already being replaced by your salary sacrifice.

If you’re unsure whether a bucket strategy is for you, there are alternatives to managing the risk in your retirement portfolio. You might consider a lifetime pension or annuity for part of your savings, or keep an eye out for other investment options coming into the market.

One such option released recently is CPIplus from Hostplus. This option returns a set percentage above CPI annually that is determined in advance. The return can’t be negative and yet is expected to be higher than you would achieve in alternative defensive investments. You can learn more about it here.

We expect more innovative products to be launched in the coming years as providers respond to the retirement income covenant. This covenant requires super funds to develop strategies that will assist their members to maximise their retirement income while managing investment, inflation and longevity risks.

Super funds that can manage a bucket strategy for you

Super funds are working hard to provide more innovative and user-friendly solutions for retirement. Some have chosen to provide pension products that can run a bucket strategy automatically, without the need for input from you. 

Our research uncovered EquipSuper and VisionSuper as funds offering this service.

AustralianSuper offers a similar option they call ‘smart default’. This places 12% of your initial investment in cash and the remainder in a balanced option. Your pension payments are drawn from cash until there is no balance remaining, after which payments will come from the balanced option. Your annual pension payment starts at 6% of your balance and begins to increase once you turn 80. This is similar to a bucket strategy but doesn’t top up your cash bucket after it is depleted. This means that unless you change your investment strategy in future, your whole balance will be exposed to the balanced option after a few years.