One of the key decisions financial advisors and their older clients face is whether to use a systematic withdrawal plan (SWP) or a “bucket” approach – whereby assets are grouped by the time horizon in which they will be used – to create sustainable retirement income.

According to a recent study on generating retirement income from the Denver-based Financial Planning Association, 50% of advisors say they follow the SWP strategy and 28% favour the time-segmentation, bucket approach.

To help advisors choose between the two, Des Moines, Iowa-based Principal Financial Group recently released a research paper that explores their relative merits.

There are different kinds of bucket systems, but author Noelle Fox focused on the most common approach, which allocates client assets according to early, later and more distant retirement phases.

The goal is to produce the cash flow the client needs while maintaining the nest egg through the expected lifetime.

For the earliest phase – say, three to five years – the advisor would set aside a bucket that will meet the client’s income needs through cash and cash equivalents. For the middle phase, which might extend from five to 15 years, the next bucket would contain fixed-income securities and some equities. The third bucket, designed to meet needs for 15 or more years into the future, would concentrate largely on equities.

This strategy redistributes the assets among the buckets periodically, aiming to create income to fund the next few years, generally from the most liquid assets.

In contrast, SWPs involve periodic withdrawals of a predetermined amount – most often, 4%-5% of the portfolio – no matter how aggressively or conservatively the assets are invested.

Fox’s analysis used a target-date fund – in which the mix of investments gradually shifts to more conservative asset classes as the retiree ages – set up for investment throughout the retirement period, not just to the target date.

The bucket strategy sets asset allocation based on market movements, while a target-date fund’s mix is based on a “glide path” customized for the client’s age; thus, investment results may vary, Fox says, but not necessarily by much.

Although the bucket strategy can be time-consuming for advisors to implement and maintain, it does offer clients a greater feeling of self-control, Fox says: “For retirees feeling overwhelmed by the many decisions they face as they enter retirement, a bucket strategy may help them divide what they see as one large, stress-inducing problem into smaller, more manageable pieces.”

Linking portions of money directly to goals, Fox adds, promotes self-control and serves as a form of mental accounting.

In addition, clients may have an easier time staying the course during periods of market volatility because they can see where their cash flow will come from – and that they probably have a decade or more to allow for any declines in the equities bucket to recover.

On the other hand, a SWP approach is simpler to implement and typically generates a higher degree of income sustainability, factors that may account for the wider adoption rate of this strategy by advisors. IE

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