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Use the Bucket Plan to Secure Your Dream Retirement

Use the Bucket Plan to Secure Your Dream Retirement

| February 29, 2024

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Happy New Year!  If retiring is part of your 2024 plan, generating an income to replace your paychecks will be top of mind.  If you are like most pre-retirees, you may have questions such as, “When can I stop working?”,

 “How much income will I have in retirement?” and “How long will my money last?”

With retirement comes the making of many decisions, often under pressure, time constraints, and confusion.  Many decisions, once made, are irreversible.  This is a significant life change, and over half of pre-retirees have never done a simple retirement income calculation, let alone understand how best to structure their investments for retirement income. (American College).

All these uncertainties can take the joy out of your retirement. Getting your arms around these issues before retiring or early in your retirement years provides a longer runway to course correct if necessary.  Not seeking the answers to these questions may lead to a reduction in your retirement income.  David Blanchett, PhD, CFP®, CFA, managing director and head of retirement research for PGIM DC Solutions, previously head of retirement research at Morningstar, presented research, “Alpha, Beta and Now…Gamma” that found better retirement decision-making around Social Security, Asset Allocation, tax efficiencies, withdrawal strategies, etc., could improve retirement income by 38%. Retirement planning is essential because the stakes are high, the issues are complex, and people who plan report feeling greater financial clarity and satisfaction.

We recently met with new clients, Jim and Sandy.  They were filled with anticipation for this next chapter in their lives and were anxious to retire so that they could spend part of the year down in Florida and part of the year on Long Island, where their brand-new granddaughter lived.  Sandy had already retired from a part-time job the year before.  Jim was aiming to retire next September.

Jim and Sandy were great savers!  They had paid off a mortgage, put three kids through college with no debt, and saved nearly 2.5 million dollars—all this by the age of 63!  Now, they were coming to us to learn if this was feasible.  Their first question was, “Do you think we can do this now?” 

“Jim, Sandy, we need to gather additional information.  You have done a great job on the surface. We need to start with your definition of a successful retirement.  From there we can back into the answers.”

Step one of this planning is sketching out a draft Bucket Plan.  When we sat down with Jim and Sandy, we began by completing an Income Gap worksheet.  At the top, we put Jim’s monthly net salary (approximately $9,000 after taxes, his 401(k) contributions, etc.)   They felt having this amount continuing to hit their checking account each month would allow them to maintain their lifestyle.  We then looked at their Social Security Benefit statements.  As we hadn’t analyzed which claiming strategy would work best for them, we deferred to our go-to strategy, Jim as the higher wage earner would wait until age 70, and Sandy, with the lower benefit would claim at her Full Retirement Age of 67.  Both those monthly amounts were added to the Income Gap worksheet.  Then we spoke about other income that may come on board in retirement.  Any part-time work?  Any pensions?  Yes, turned out Sandy had a small pension from a department store she once worked for.  That monthly amount went in as well.  Will any extra expenses come on board?  Yes, so we added in upkeep and fuel costs for a new boat purchase and annual contributions to their new granddaughter’s 529 plan.  Any expenses decrease in retirement?  For them, no.  We were then able to calculate what their Income Gap would be once all sources of guaranteed income were in place.  Their Gap equaled $4,000 a month, meaning $4,000 would need to come from their portfolio every month.  This number is significant because we can begin to answer the questions: Do we have enough? and how much income will I have?  Here, it's all about the Distribution Rate:  At first glance, we’ll look at $48,000 ($4,000 x 12 months) divided by their portfolio balance of $2.5 Million.  This equals a distribution rate of 1.92%. We prefer the initial distribution rate to be about 4% or less, but may temporarily increase this percentage to maximize guaranteed income sources.  We know that we have not factored in some of the items we mention below, like taxes, which may be a retiree’s largest expense (if not, it may likely be healthcare). However, with a 1.92% initial rate, we feel comfortable that the plan is feasible even in the early years, when they will be over-withdrawing temporarily to maximize Social Security.

 We then drew three buckets on a piece of paper.  We asked them how much cash they felt comfortable keeping in their bank’s savings account.  They prefer to have $75,000 in this account at all times.  We wrote $75K down in bucket #1.  Then we spoke about what they thought they would like to accomplish over the next 12 months that required money.  Jim wanted to buy a boat for their Florida house which would cost $50,000.  We wrote that amount down in Bucket 1 as well. Then we took the income they needed hitting their checking account this year when Jim stops working in September.  They need  $9,000 net a month:  We put $27,000 in Bucket 1 as well  (October, November & December).

Then we were on to Bucket 2.  Here is where we put 5 years of their income Gap down. ( $48,000 x 5 = $240,000).  Then, we add an inflation hedge to handle the growth we need over five years.  We added a Medicare Bridge for both Jim and Sandy which would cover the cost of their medical insurance (COBRA) for two years prior to their age 65.  Then we calculated a Social Security bridge, 7 years for Jim and 4 years for Sandy.  This went in Bucket 2 as well.  Also going into Bucket 2 would be a dollar amount for taxes.  As most of Jim and Sandy’s wealth was in pre-tax retirement accounts, we needed to account for a tax budget. In addition, would they be doing partial Roth Conversions requiring tax payments? We put down $120,000  (Any amount we add to the sketch here would be a placeholder because we hadn’t completed their full financial plan with different spend-down scenarios.)  Bucket 1: $152,000, Bucket 2: $730,500.

 We put all remaining dollars from their $2.5 Million portfolio in Bucket 3: $1,617,500.

 When the buckets are sketched, we tell the Buckets of Money story.  Everything you need in the very short term, the next twelve months, goes into Bucket 1 and is in cash/savings/money markets.  Everything you will need over the next 5 (or 10, depending on the client) goes into Bucket 2 and is invested conservatively; it will never make a lot of money, but the key is it should never lose a lot of money.  Why?  The most important risk to manage in retirement is the Sequence of Return risk (which is also called Withdrawal Risk).  Most pre-retirees biggest mistake is going right from their saving years into their spending years, skipping the preservation step.  The preservation step is segregating what you know will need to come out of your portfolio over the next 5 (or 10) years so that it is not subject to a down market cycle.  This prevents you from selling positions when they are down in value, which is especially damaging when you begin to “spend down” your portfolio.  

Your remaining portfolio balance in Bucket 3 will be invested for growth (a healthy percentage of stock).  Bucket 3 has two critical jobs!  It needs to grow over the long term to help battle inflation and longevity risk and replenish bucket 2 before it gets too low.

Once we explain the draft bucket plan to Jim and Sandy, we ask them if they have any questions and are comfortable with what they see.  Looking at it this way, it is easy to project how much the next five years may cost them and how different Bucket 2 and 3 would look if Jim retired two years later at 65 when they wouldn’t need a Medicare bridge and have a smaller Social Security Bridge.  Most clients tell us that seeing it laid out this way helps them make better and more informed retirement decisions.  For Jim and Sandy, this draft bucket plan provided the clarity they needed and reinforced their decision to have Jim retire this September.

 The decisions you make leading up to retirement are critical to your success and most decisions are intertwined with your income, investment and tax strategies.  It gets tricky and sometimes it is ridiculously complex.  It is easy to trip up. Comprehensive planning creates a roadmap for informed decision making. Remember, academic studies show making good decisions can add up to 38% to your retirement income. If you would like to start an income plan of your own, download our “Starter Pack” worksheets.  They will help you visualize your retirement lifestyle, assess the costs, and estimate what retirement income is possible for you. 2024 will be a defining year for you! Happy New Year!