Is a bucket strategy the solution for your retirement income plan?

The bucket approach to managing retirement portfolios was pioneered by US financial planning guru Harold Evensky in 1985.

Bucket strategies are designed to balance the need for income stability and capital growth in retirement. The aim is to make your money last, while still giving you the flexibility to make a lump sum withdrawal for expenses like holidays or home renovations.

Although there are several ways to use the bucket concept, the most common is a three-bucket strategy.

The approach is popular with many retirees because it eliminates the risk of having to sell your investments when the market is down to pay for regular living expenses. Its popularity has seen some industry super funds begin offering super pensions based on the strategy.

How does the strategy work?

The bucket approach divides your retirement into different phases, with a separate account established to meet your financial needs as you age.

A three-bucket retirement strategy, for example, divides your retirement savings into three accounts (short, medium and long-term), each of which has a different role:

Once the bucket strategy is operational, the only bucket with automatic withdrawals is bucket 1. The other two buckets are adjusted manually – often annually – with funds from bucket 3 refilling bucket 2 and bucket 2 refilling bucket 1.

How your retirement buckets are invested

Each of your retirement buckets has a different time horizon, objective and asset allocation:

Bucket	Time period	Investment goal	Asset allocation
Bucket 1	Short-term	Provide income for your living expenses over the next 2–3 years Provide immediate cash for emergencies	Invested in cash or accessible, short-term deposits
Bucket 2	Medium-term	Provide income for years 3 to 6 of your retirement Hold money to refill bucket 1 annually as it reduces	Invested in a conservative investment option, or a high-quality portfolio of assets such as bonds Small component may be allocated to high-quality, dividend-paying shares
Bucket 3	Long-term	Provide income for the long-term (7-plus years after retirement) Grow retirement savings to protect against inflation	Invested in diversified growth investment option, or growth assets like shares.

Bucket 1 is designed to fund your short-term living expenses, so it’s invested in assets that do not fluctuate with the market (like cash), as you need this money to live on and pay your fixed expenses. Your cash bucket provides peace of mind you can pay your bills and ride out the normal ups and downs affecting your longer-term investments.

The other buckets contain assets that won’t be needed for several years or more, so they are invested in diversified strategies designed to deliver both medium and long-term objectives.

Case study: Three bucket retirement strategy using a pension from your super fund

Deepa is aged 67 and has $560,00 in her super account.

When she retired from full-time work in July 2019, Deepa decided to commence a three-bucket pension with her super fund.

She also decided to take the 2.5% minimum pension payment amount set by the government. As she is 67 years old, this amount is $28,000 a year. For more information, read SuperGuide article Minimum pension drawdown rates halved for 2019/2020 and 2020/2021.

As a result, Deepa’s pension account balance is invested as follows:

Short-term bucket (covers pension payments for 3 years)	3 x annual minimum pension payment amount x $28,000 = $84,000
Medium-term bucket	($560,000 – $84,000) ÷ 2 = $238,000
Long-term bucket	($560,000 – $84,000) ÷ 2 = $238,000

Each of Deepa’s pension buckets is invested using a different investment strategy designed to suit the time period for which she is investing.

Her super fund invests her short-term bucket in its cash investment option, while her medium-term bucket is invested in the fund’s conservative investment option. The money in her long-term bucket is invested in the growth investment option.

Deepa’s super fund rebalances the money in each of her buckets annually to maintain the desired level of money in each bucket. This ensures she always has a minimum of two years of pension payments in her short-term bucket as she moves through retirement.

4 drawbacks to the bucket strategy

Using the bucket strategy to manage your retirement savings is not for everyone. As with any investment strategy, this approach has some issues you need to consider:

1. Establishing the strategy can be complex

There is no definitive or best way to set up a retirement bucket strategy. Opinion varies over whether you should use two or three buckets, while there are also approaches using buckets based on your needs and wants.

Working out the right asset classes and investments to use for each bucket can also be complex.

2. Managing it can be tricky

A bucket strategy is generally not set-and-forget. Maintaining the various accounts and keeping the right amount of money in each bucket can be time consuming.

You also need to establish rules for when and how you will replenish your buckets and what you will do with returns if your investments do better (or worse) than expected.

3. Compatibility with a transition-to-retirement (TTR) strategy

A bucket strategy may not be suitable if you are also using a TTR strategy. As this approach involves withdrawing from your super account while simultaneously salary sacrificing money back in, you are in effect recycling your cashflow.

For more information, see SuperGuide article Guide to transition to retirement pensions (TTRs or TRISs)

4. Unsuitable for conservative retirees

A bucket strategy may not be right for retirees with a conservative risk profile. With historically low interest rates for your cash bucket, you must be prepared to invest in riskier assets in buckets 2 and 3. If not, the strategy may not work as your savings will not be growing enough to replenish your first bucket.

For more information, see SuperGuide article Super investing: What is your risk profile?