A Smarter Way to Manage Retirement Income

 After working with retirees for more than two decades, I’ve observed that many of them have the same feelings when they talk about money. One of the most consistent emotions is fear—spending their hard-earned savings in retirement often feels scary. When inevitable market turbulence strikes, this fear often turns into outright anxiety, leaving retirees feeling uncertain about their financial security.

Fortunately, there’s a way to alleviate much of this anxiety. Over the years, I’ve developed a modified bucket approach to retirement income planning. Unlike the traditional bucket strategy that divides assets among cash, bonds, and stocks, this approach is rooted in practical experience that shares similarities to a classic barbell strategy. It prioritizes emotional comfort and peace of mind—a “return on sleep” that theoretical models often overlook. It’s not just an approach that “feels” better, the data suggests that following this approach leads to higher returns. 

Protection Against Sequence of Returns Risk

The sequence of returns risk—the danger of poor investment returns when you are taking distributions from your retirement savings—can significantly harm your portfolio if you’re forced to sell investments during a downturn. A spending bucket helps to mitigate this risk by setting aside five years of income in stable, fixed-income investments, allowing your growth assets to recover during market turbulence.

When markets decline, withdrawing from the spending bucket instead of selling stocks protects your portfolio from locking in losses. This strategy creates a buffer against market volatility and allows retirees to maintain their spending plan without the anxiety of selling at a loss.

Having worked with hundreds of retirees in the trenches of retirement, I’ve seen firsthand how this approach can transform uncertainty into clarity and confidence. But before we dive into the details of how it works, it’s important to understand the foundational pieces that need to be in place. These elements lay the groundwork for a plan that not only meets your income needs but also can minimizes a lot of stress in retirement. 

First, You Need a Real Plan

The foundation of a confident retirement income strategy is a real, comprehensive retirement income plan. A well-constructed plan isn’t just a collection of numbers, projections, and pretty charts—it’s a tool that provides clarity and confidence into how your retirement income will work.

An effective plan gives you multiple data points that guide your spending decisions. It breaks down exactly where your income will come from each year, what the tax implications will be, and how your portfolio will evolve over time. The plan should allow you to compare various scenarios, including:

• Different Social Security filing ages
• Various withdrawal sequences
• Testing of various spending levels
• Roth conversion strategies
• Pension options
• Other important factors unique to your financial situation

Ideally, the plan will present this information in a clear and digestible format. For example, the plan that we present to clients shows each scenario compared to the other scenarios in a simple line graph that shows the cumulative tax burden and portfolio balances for each scenario. Visual tools like these make it easier to understand the trade-offs and confidently choose a strategy that aligns with your goals and comfort level.

Once you have this clarity, you’ll be ready to determine your distributions for the next five years. This is the first and most critical step in setting up your spending bucket. 

Set Up Your Spending Bucket Account

Once you have a clear plan in place and know your income distribution needs for the next five years, the next step is setting up your spending bucket. This bucket is the account—or group of accounts—from which all your retirement distributions will come.

To maximize its effectiveness, your spending bucket should be kept separate from your growth account. For example, you might label it “Spending Account” or something similar to create a clear mental distinction. This approach, known as mental accounting, isn’t for everyone, but for most retirees, it provides significant peace of mind. During volatile market periods, knowing that your short-term spending needs are covered by this dedicated account can make a world of difference.

When setting up your spending bucket, there are a few critical considerations:

1. The Account Type Matters:
• If your distributions are coming from an IRA, the spending bucket should also be an IRA. This avoids unnecessary taxes that could result from moving funds into a taxable account. If you’re drawing from taxable accounts, the same principle applies—use an account designed for spending without changing the tax treatment unnecessarily.
2. What Goes in the Spending Bucket?
• This account should not hold cash alone but should be invested in fixed-income securities with maturities that align with your income needs over the next five years. For example, you might use a ladder of bonds or CDs, ensuring that funds are available when needed without being subject to market volatility.
3. Growth Account Allocation:
• The remaining portion of your portfolio—the growth account—should be invested in equities, adjusted for your individual risk tolerance. Important Note: The spending bucket represents the minimum amount of fixed-income assets you should hold in your overall portfolio.
4. Replenishing the Spending Bucket:
• Replenishment should only occur in years when the market delivers positive returns. This ensures you aren’t forced to sell growth assets at a loss during market downturns, preserving the long-term health of your portfolio.

By separating your spending and growth accounts, you create a system that provides both stability and growth potential. The spending bucket safeguards your short-term needs, while the growth account keeps you invested for the long term. This balance not only ensures financial security but also minimizes anxiety, giving you confidence no matter what the market does.

The Data Supports This Approach

A recent study by DALBAR examined the spending bucket strategy, called Prudent Asset Allocation (PAA), alongside the traditional 60/40 mix, referred to as Arbitrary Asset Allocation (AAA). While their methodology includes some minor differences from my approach, the key findings reinforce the effectiveness of tailoring an allocation strategy to actual spending needs rather than arbitrary percentages.

The results speak for themselves. Between 2001 and 2020, PAA outperformed AAA in 65% of single-year returns and 60% of rolling 10-year periods. This consistent outperformance underscores the advantage of aligning investments with specific retirement goals.

One of the critical reasons for PAA's success is its resilience during market downturns. Over this period, there were four years of negative returns. The traditional 60/40 mix would have required selling stock investments to maintain allocation and generate income, often locking in losses during market declines. By contrast, the spending bucket strategy ensured that retirees had a stable source of income, allowing growth assets to recover fully before being accessed.

The study also validates the five-year spending buffer. Historical data shows that even in severe downturns, markets typically recover within five years. By setting aside five years of spending in stable investments, retirees can avoid tapping into growth assets during volatile periods, preserving long-term financial stability and peace of mind.

Does This Work for Everyone?

I think it can, but it’s important to stay flexible. Everyone’s risk tolerance and capacity vary, so this approach needs to be tailored to fit individual circumstances and preferences.

For example, let’s assume a near-perfect retirement scenario. A client and their spouse are retiring, and they need a 4% distribution from their savings to meet their income needs. Using the five-year spending bucket strategy, this would mean allocating 20% of the portfolio to fixed income and the remaining 80% to stocks.

However, if that client has a strong aversion to seeing their portfolio value decline, an 80/20 allocation may feel far too aggressive, even if it’s mathematically sound. This is why our approach is to let the 5 year income stream determine the minimum amount of fixed income in a portfolio. For those with a lower tolerance for fluctuating account values, the solution isn’t to abandon the strategy, but to adjust it. One way to address this is to hold additional fixed-income assets within the growth account. This adjustment provides a greater cushion against volatility while still maintaining the structure and benefits of the overall strategy.

The key takeaway is that this approach can work for most retirees, but it must be customized. By aligning the spending and growth buckets with both financial needs and emotional comfort, the strategy becomes not only effective but also sustainable for the individual. 

Tailoring Your Retirement Strategy to Fit Your Needs 

The big takeaway is that while conventional wisdom approaches like the 60/40 allocation provide a solid foundation for big-picture thinking about retirement income, they are not the only option. Strategies like the modified bucket approach offer a flexible, data-backed alternative that prioritizes both financial stability and emotional comfort.

By creating a clear plan, establishing a spending bucket, and adjusting the strategy to align with individual risk tolerance, retirees can confidently navigate market volatility. This approach isn’t just about maximizing returns—it’s about crafting a retirement income plan that works in the real world, helping retirees achieve peace of mind and fully enjoy this exciting new phase of life.

Retirement doesn’t have to be a source of anxiety. With the right tools and guidance, it can be everything you envisioned: secure, fulfilling, and stress-free.