How Federal Employees Can Manage Their Investments In Retirement: The Bucket Strategy

As federal employees prepare to retire, they must shift from the accumulation mindset to the distribution mindset; said differently, they must shift from the saving mindset to the spending mindset. This change comes with many challenges, chief among them is deciding on a retirement income strategy.

When developing a plan for turning your retirement assets into an income stream, you have three common strategies that you can select from, which include: systematic withdrawals (4% Rule), time-based segmentation (Buckets), and essential versus discretionary income (Income Floor). In this article, we will discuss the bucket strategy.

What Is The Bucket Strategy?

The bucket or time-based segmentation strategy divides assets into different “buckets” based on time horizon and risk tolerance. For example, it’s common to divide the buckets according to the time you’ll most likely need them: short-term, mid-term, and long-term.

The goal of this retirement income strategy is to manage stock market risk while allowing your portfolio to grow and thus mitigating longevity risk (the risk of outliving your money).

This strategy works by transferring assets between buckets. The idea is that as you use money in your short-term bucket, you’ll replace it periodically by selling assets from your medium-term bucket; and when growth assets are performing well, you’ll sell a portion of your long-term bucket, capture the gains, and invest that money in assets that make up your medium-term bucket. Now let’s examine each bucket.

Bucket #1: The Short-term Bucket

The short-term bucket is where you’ll keep the next three or so years worth of TSP withdrawals. Because you’ll rely on this bucket for your income needs, it should be highly liquid, risk-free, and readily available. In other words, since this bucket is meant to provide stable income and Not Generate Growth, it should be invested in cash or cash equivalents, think checkings, savings, CDs, or the G fund.

Once you’ve determined an appropriate amount for the bucket, you’ll want to rebalance your portfolio regularly. So, as you spend cash, you’ll sell portions from your mid or long-term buckets to replenish the cash bucket. If stocks are up, you’ll likely want to refill from your long-term bucket, and if stocks are down, you’ll sell from your mid-term bucket.

Bucket #2: The Mid-Term Bucket

This bucket will typically hold 4 years’ worth of TSP withdrawals. Like bucket 1, the purpose of this bucket is income production and stability. However, the assets in this bucket are not required to be liquid or risk-free, although they should be much safer than stocks.

With a higher risk than the cash and cash-like assets in your short-term bucket, the assets in the mid-term bucket usually consist of high-quality fixed-income assets, such as bond funds (think F fund). Unlike the assets in the short-term bucket, these assets will likely lose value during a downturn, yet they will generally be much more stable than the stocks in the long-term bucket.

Again, assets from this bucket and your long-term bucket will refill your short-term bucket as needed. Additionally, dividend and interest earnings can be diverted as an income stream to bucket one.

Bucket #3: The Long-Term Bucket

Lastly, we’ve reached the growth engine of the bucket strategy: the long-term bucket. The purpose of this bucket is to grow as much as possible. Whereas buckets one and two are meant to help protect your portfolio from market risk, this bucket helps protect you against the risk of running out of money in retirement.

The funds in this bucket won’t be needed for seven or so years. Hence, the long-time horizon allows this bucket to be dominated by growth assets, such as small-cap stocks and growth stock funds. Since the remaining money will be held in this bucket, it will generally be the largest portion of the overall portfolio.

Unlike buckets one and two, which had low risk with low returns, bucket three will have significantly more risk and growth potential. And though this bucket will see large swings in value due to the ups and downs of the stock market, the long-time horizon means that you can rely on the first two buckets until bucket three recovers. Likewise, during strong stock market performance, you can trim bucket three and divert the funds to the other buckets as needed.

Final Thoughts

Although the bucket strategy can effectively transition your TSP from the saving phase to the spending phase while mitigating stock market swings and the risk of outliving your money, there is no single “right” answer for everyone.

Yet, everyone can benefit from starting their retirement planning early. That said, planning your retirement can be challenging and stressful, which is why I recommend every federal employee works with fee-only Certified Financial Planner™ to develop their personalized retirement plan. The goal, after all, isn’t to worry about running out of money in retirement; it’s to enjoy the life you envisioned.

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2023 Legislative Change Notice

The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Author: Jose Armenta, MsBA, CFP®, ChFC®, EA

Hi, I’m Jose Armenta, a Certified Financial Planner practitioner. For over 14 years, I have worked with or among federal employees, from serving in the Marine Corps to my stint as a police dispatcher and now as a financial planner specializing in helping FERS federal employees. In that time, I have spoken to hundreds of federal employees about their benefits and retirement. Helping federal employees maximize their benefits, reduce taxes, and live confidently is a passion of mine. When I am not perfecting financial plans, you’ll find me at the shooting range, playing the drums, or breaching blanket forts with my three little ones.