How to Create a Retirement Paycheck – The “Three-Bucket” Strategy

For all workers, payday was one of the most glorious days. Thus, in retirement how can you generate a new type of consistent and ongoing paycheck?

Parsec believes that a sustainable withdrawal rate (SWR) is 4% for most retirement time frames. Factors that can impact this rate include your length of retirement, when you retire, what is your life expectancy and your desire to leave a legacy to others.

The objective is to withdraw 4% from a balanced portfolio of 60-80% stocks and 20-40% bonds. You can expect a 6-8% long-term total return and a 2-4% long-term portfolio growth rate.*

For your retirement paycheck, decide the frequency of your distributions, such as the 1st of the month, so that you know when to expect it. Then, decide which types of accounts you are going to withdraw from and know the tax implications.

Because portfolio income is lower than 4% the investor will have to plan for periodic principal liquidations. Estimating the size and frequency of these forced liquidations is very important so that you do not get forced to sell stocks when they are at a low point. To help guard against this I encourage Parsec clients to follow the three-bucket strategy:

1. Bucket one is having the cash and short-term bonds in an amount sufficient to cover 2-3 years of anticipated cash flow needs.

Try to map out the next 36 months of your expenses. Be sure to look at expenses that are irregular in amount and frequency such as travel, car replacement, home maintenance and taxes.

2. Bucket two should be invested in various fixed income asset classes and should approximate 3-9 years of spending.

It is important to diversify between account types. When you have taxable accounts and cash you are likely to pay less income tax in early retirement. If not monitored carefully, you could be left with a portfolio that only consists of IRAs toward the end of retirement, which could mean years of unpleasant tax bills or a faster drawdown rate later in retirement. Estimating your taxes in November of each year gives an investor a chance to decide whether they would like to do partial Roth IRA conversions in the years after retirement but before age 70.5.

If you do have to sell principal, I recommend the following strategy:

Parsec's strategy on liquidating principal if need-be

3. Bucket three are funds not needed for 10 years and should be invested in dividend-paying stocks.

Some stocks have very consistent dividends. Parsec Founder Bart Boyer calls them “go fishing” stocks because you can go fishing and not worry about the dividend changing or going away. But, do not prioritize just stocks that have dividends because you need to diversify.

It’s not the size of the dividend that matters but look at the dividend payout policy. Finding a dividend payout policy that is small enough that a company can hold the dividend during periods of economic weakness or bad company performance, but large enough for shareholders to benefit by a stout dividend. As a result of the market love affair with the dividend it makes company management reluctant to do anything that might jeopardize it.

For more details on my three-bucket strategy, please download my full presentation, “How to Generate a Retirement Paycheck.”

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*SOURCE: KITCES and 2022 Morningstar/Ibbotson. Long-term total returns are based on a blended portfolio of large-cap stocks, small-cap stocks and US investment-grade bonds. Long-term portfolio growth rate refers to the long-term total returns after 4% annual withdrawals.

NOTE: This blog offers general information and should not be acted upon without obtaining specific advice from a qualified professional. The information is not intended as investment, tax or legal advice, nor the solicitation for the purchase or sale of any security.

Rick Manske, CFP®, BFA™
Chief Executive Officer

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