Bucket Planning

Bucket Planning is Not Just Bucketing

Published May 28th, 2020 in Blog |

Bucket planning is about more than just bucketing. But what exactly does “bucketing” mean to advisors, and how does it differ from bucket planning? In a recent episode of The Bucket Plan Podcast, Jason and Dave sat down with retirement expert, Jamie Hopkins, to discuss the intricacies of a holistic bucket planning process and how different strategies can be used within The Bucket Plan.

In a recent episode of The Bucket Plan On-Demand Series Podcast, Jason and Dave sat down with retirement expert, Jamie Hopkins, to discuss the intricacies of a holistic bucket planning process and how different strategies can be used within The Bucket Plan.

One of the challenges around bucketing, Jamie explains, is that not everyone has the same view of it. Most advisors think of bucketing as more of a bridging strategy, based on the two-bucket model made popular by Harold Evensky. As more steps on bucketing became defined, and people were made aware of a three-bucket approach, the concept of bucketing became more akin to time segmentation. However, as Jamie continues, “It was really just kind of a very simple play on mental accounting. And, you know, I think that’s continued to grow over time.”

Bucket planning as we know it now goes beyond just mental accounting. It includes the strategies behind how to fill those buckets, how and when to move money between the buckets, and how to bring it all into a plan that’s right for each of your client’s unique circumstances.

Focusing on creating income out of the Soon Bucket, Jason, Dave and Jamie go on to discuss three different strategies to use in your bucket planning.

Bridging

Most of the time, when advisors think of the concept of bucketing, they’re thinking about income distribution planning – laddering bonds, laddering CDs, laddering annuities – time segmenting money so that when one segment, or bucket, is depleted, the next one then kicks on. The idea of bridging is exactly what it seems. You’re essentially structuring these time segments so that by the time clients cross over this period of time, they’re on to the other side.

The bridge is probably the most common strategy people think of when they think about bucketing. Essentially bridges are used in the Soon Bucket to buy the client the appropriate time horizon for their more growth-orientated money in their Later Bucket to continue to grow. A 65-year-old client, for example, is getting ready to retire. A good use of bridging would be to buy a five-year bridge to get the client to age 70, when you know that Social Security will probably be higher.

There can be multiple bridges built into a client’s Bucket Plan and, as a rule of thumb, advisors want to talk to clients about reloading their bridges when they have five years or less of income in their Soon Bucket. As Dave puts it, “You don’t want to allow the bridge to run out. You don’t want to be to the other side of the bridge and then be like, ‘Oh no, we need to build another bridge.’ Because what could happen at that time, is we could be in a market environment like we were in March of 2020 or 2008/2009 and the market is down 30%-50% and it’s not an opportune time to sell assets out of your Later Bucket to reload (buy a new bridge) in your Soon Bucket.

Flooring

Flooring is another strategy for guaranteeing ongoing income out of the Soon Bucket. Flooring is essentially buying lifetime income annuities – similar to a Social Security or pension check. Jason explains, “You’re giving money to an insurance company to guarantee you a paycheck for the rest of your life. It doesn’t matter what chassis you’re doing it on, a fixed or variable. At the end of the day, you know, you’re just giving the insurance company money to give you a check for the rest of your life.”

Every client’s plan has some type of floor. Almost everyone in the United States is going to have some sort of pension or Social Security to rely on. So, as Jamie points out, flooring really becomes more of a conversation on how much of a floor your client wants or needs.

Financial thought leaders like Tom Hegna have taken this concept of flooring one step further, applying the flooring strategy to clients’ essential versus discretionary spending. In this approach, advisors work with clients to determine their everyday, essential expenses and then use flooring to create an income stream that will guarantee those expenses will always get paid. When clients floor their essential, mandatory expenses, they can then plan to pull discretionary funds from other sources of income.

Portfolio Yield

Clients aren’t limited to one of these strategies in their own Bucket Plan. Jason, Dave and Jamie discuss their experiences with combining the two in the same plan, as well as a third approach – portfolio yield.

Traditional portfolio yield is pretty straight forward as a concept. You have a client invested in a traditional portfolio built to generate dividends and interest. The client then lives off of the dividends and interest, never tapping into principal. By not having to sell shares (tapping into principal), they essentially eliminate sequence of returns risk. The disadvantage of portfolio yield to most clients is that it might not be an viable option. Portfolio yield requires the most amount of capital to implement and generally only works for higher net worth clients who can generate enough dividends and interest to live off of.

Another disadvantage of portfolio yield is that the income is not guaranteed. Clients don’t necessarily have the same level of reliability from this strategy as they may from others. On the plus side, however, portfolio yield eliminates sequence of return risk because clients are not selling into principle. They’re simply living off of the dividends and interest.

Conclusion

Bucket planning as a process is the time segmentation of money based on the purpose and the time horizon of people’s assets. Based on the purpose and time horizon of the assets in the Soon Bucket, there are three income-generating strategies that go beyond advisors’ traditional definition of and thoughts on bucketing. There’s bridging, which has also been known as bucketing, there’s flooring and there’s portfolio yield. Bridging is often the most accessible option for most clients, because both flooring and portfolio yield approaches require more money.

All three strategies are great income planning options and the real power of bucket planning is how it can be used as a communication tool for advisors and clients to talk about all their options and to come up with a plan that is best for each unique situation. Good bucket planning is about knowing your client and what resources they’ve accumulated. The bucket planning framework then is more than any one strategy. It is an open architecture approach that allows you to discuss all the strategies, simple or complex, in a way that clients understand and that makes them feel comfortable.

For more information on this concept, putting these strategies into practice, and how bucket planning can go beyond income planning, listen to the podcast.


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Dave Alison

Article Author

Dave Alison

Dave Alison, CFP®, EA is a founding partner of C2P Enterprises, driving a vision to help financial advisors across the United States simplify financial planning. Dave’s professional capabilities to coordinate tax, financial, insurance and estate planning needs are what led him to found Alison Wealth Management as a boutique tax, financial planning & investment management firm bringing household CFO services to affluent families & high-income professionals across the United States.

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