When it comes to saving for retirement, maybe you’ve done everything right. You started early, maxed out your 401(k) plan, invested in a diversified portfolio and avoided costly mistakes, such as cashing out your retirement plan. Fantastic. But now comes the hard part: making sure you don’t outlive your money.
That’s a tall order for today’s retirees. Taxes, unpredictable investment returns, rising health care costs and inflation down the road can significantly erode the value of your nest egg. And perhaps the biggest challenge is that you’ll probably need the money for a long time. A 65-year-old man has a life expectancy of 19.3 years; it’s 21.6 years for a 65-year-old woman. If you’re married, there’s a 45% chance that one of you will live to age 90 and a nearly 20% chance that you or your spouse will live to 95.
Fortunately, there are steps you can take to generate extra income and extend the life of your portfolio. Let’s take a look.
A bear market just as you enter retirement couldn’t come at a worse time if you’re forced to sell securities after prices have plunged. That’s where the “bucket system” can help. Jason L. Smith, a financial adviser in West Lake, Ohio, and author of The Bucket Plan, uses the system with clients, splitting their assets among three buckets: “Now,” “Soon” and “Later.”
The Now bucket holds what you’ll need in the short term and should be parked in a savings account. Smith recommends setting aside enough so that, when added to Social Security or a pension, it will cover your basic expenses for up to a year. It should also have enough for major expenses that are likely to crop up over the next couple of years, such as paying for a new roof, plus cash for unexpected emergencies.
Money in the Soon bucket will be your source of income for the next 10 years. Smith recommends investing in a fixed annuity or high-quality short-term bonds or bond funds. As the Now bucket is depleted, you withdraw money from the annuity or sell some of the fixed-income investments in the Soon bucket to replenish it.
The assets in the Later bucket aren’t meant to be tapped for more than a decade into your retirement, so they may be invested more aggressively in stock funds and alternative investments such as REITs. This bucket can also include life insurance or a deferred-income annuity, which pays income later in life.