Some financial professionals suggest individuals set up different ‘buckets’ for retirement income, and defined contribution (DC) retirement plan sponsors can help them do so.
Harold Evensky, chairman, Evensky & Katz/Foldes Financial in Coral Gables, Florida, says one “bucket” strategy is based on time or age: individuals would have a “bucket” of assets to use from age 65 to 75, another to use from age 75 to 85, and another for after age 85, for example.
The bucket approach Evensky has suggested since the 1980s is a split between a cash flow reserve and an investment component. Some of an investor’s portfolio needs to be invested over a long time horizon to maximize risk, he explains. But, for income needed in the short term, investors need to minimize risk. Evensky tells PLANSPONSOR he would suggest that individuals carve out of their portfolios the amount of income they would need in the next one or two years, and the rest of their portfolios should be invested for the long term.
DC retirement plans can offer options to help participants with these ‘bucket’ strategies. Sponsors of DC retirement plans can and should help individuals with a withdrawal strategy, and have the tools to help them set up buckets for retirement income, says Roberta Rafaloff, vice president of Institutional Annuities at MetLife in New York City. “We strongly believe that retirement income should be the outcome of every DC plan,” she tells PLANSPONSOR.
She suggests plan sponsors think of income options available for DC plans as a spectrum, from maximum income flexibility to maximum income guarantees. Systematic withdrawals are on the maximum flexibility end, and immediate or deferred income annuities are on the other end of the spectrum.
MetLife recommends plan sponsors offer partial annuitization for DC plan participants. “Participants can build an income stream with some portion of their assets, and the rest can remain in the plan and continue to be invested and, hopefully, grow,” Rafaloff says.
She thinks offering participants choice is a great idea, so plan sponsors can offer participants an opportunity to purchase an immediate annuity that starts at age 65 as well as a longevity annuity, starting at age 85. “Some people think they can manage assets 10 or 15 years into retirement, but they worry about having assets if they live longer,” she notes.
Rafaloff says it is really important for DC plan sponsors to start thinking about how they are going to offer income solutions within their plans. She suggests they consider what participants are looking for, how to measure success of their plan to include retirement income, and what products they can include to make sure employees are prepared for retirement.
There are other ‘bucket’ strategies suggested by financial professionals. In fact, ask several different financial professionals what it means to set up ‘buckets’ for retirement income and likely there will be several different answers. Offering Roth options in DC plans can play a part in some strategies.
Daniel D’Ordine, a certified financial planner (CFP) with DDO Advisory Services, LLC, in New York City, advises clients who are working and in retirement-savings accumulation mode to fund three buckets of assets—tax-deferred, taxable and tax-free. He tells PLANSPONSOR the goal is to prevent a situation during retirement in which everything is in the tax-deferred bucket. “If all of the assets/accounts from which retirees are drawing are tax-deferred, then [the retirees] are at the mercy of ordinary income tax brackets,” he notes. According to D’Ordine, in many states—such as New York, California and Massachusetts—that can mean that to spend $100,000, a retiree would need to withdraw $140,000 or $150,000.
He suggests three buckets for retirement income:
- Tax-deferred – This would include employer-sponsored defined contribution (DC) and defined benefit (DB) plans, individual retirement accounts (IRAs) and non-qualified deferred annuities—all for which retirees would pay ordinary income tax on distributions;
- Taxable – This could include a taxable brokerage, mutual fund or investment account—from which retirees would pay capital gains taxes, which D’Ordine notes are currently more favorable than ordinary income taxes; and
- Tax-free – This would include Roth IRAs, Roth 401(k) or 403(b) accounts, and cash value life insurance, if appropriate. D’Ordine says municipal bonds fall into this category because the income is typically tax-free.
With these buckets, if an individual needs $25,000, she should determine the least expensive way to tap assets to get this money, D’Ordine explains. “It could be a loan or withdrawal from a cash value insurance policy, or it could be a withdrawal from a tax-deferred account, depending on the individual’s tax bracket.”
He adds that some people will be in a low tax bracket, and depending on the assets they have, having different tax buckets may not matter. However, in general, he says, “the decisions you make while accumulating savings can make a big impact on your experience taking distributions. Small decisions now can make a big difference.”
There is no one right answer for everyone, but DC retirement plans can play an important part in whatever retirement income strategy individuals choose.