Based on when you’ll need to access the funds, the bucket technique splits your retirement savings into three buckets. Its goal is to strike a balance between investment growth and easy access to your money. The first bucket is for your emergency fund and money you plan to spend on living expenses or large purchases in the next couple of years. These assets should be kept liquid in a high-yield savings account so you may access them whenever you need them, regardless of market fluctuations.
The money you plan to use in the next three to ten years goes into the second bucket. Put these monies into more secure investments, such as bonds, balanced funds or certificates of deposit (CDs)/debt funds. As you deplete the cash in your first bucket, you can sell or withdraw funds from part of your second bucket’s assets to replenish the first.
The third bucket can be for long-term requirements beyond ten years. The money set aside in this bucket can be invested into more risky investments like equity that deliver a superior long-term return and help you beat inflation. You can invest through equity mutual funds, Portfolio Management Schemes, direct equity or even Alternate Investments Funds under this bucket.
If you adopt the systematic withdrawal technique, you’ll take out a fixed percentage of your nest fund in your first year of retirement and gradually increase it to keep up with inflation each year after that. The 4 percent rule, which states that annual withdrawals should not exceed 4% of your nest egg, is a typical rule of thumb you may have heard. You may customize this to about 5% or 6% if you have a higher risk appetite. Do not keep this too high as you would need to increase this amount periodically to take care of inflation. Ie. Do not use the complete return that you are getting on your investments. In initial years, start with a lower withdrawal rate so that your capital grows and can afford higher withdrawals later to take care of inflation. Use an professional to help you achieve this if it becomes too complex for you.
An annuity is a contract you enter into with an insurance company in which you pay a certain sum of money in exchange for guaranteed monthly payments for the rest of your life. There are two sorts of annuities: immediate annuities, in which you pay the insurance company a lump sum in exchange for monthly checks that begin immediately, and deferred annuities, in which you pay the business but do not receive payments for several years. You could also look to invest into annuities through the National Pension Scheme (NPS) as well as an alternative. It is ideal not to completely depend on annuities, especially since most of them do not provide liquidity and flexibility. However, having part of it into a guaranteed or lower risk annuity can be considered for conservative investors or even to take care of your basic expenses.
A Combination Strategy
One may use a combination of the above strategies to achieve the best tax efficiency. E.g. Up to a certain extent you can use annuities as part of one of the buckets. You could use a systematic withdrawal as part of your bucket strategy as well.
Different types of savings are taxed differently by the government, and recognizing these differences is crucial to keeping more of your money. It is important to understand the taxation of various investment avenues. You may use options that are tax exempt like PPF and Insurance. Some avenues may be tax exempt up to a limit which you have to keep in mind. Capital gains may be tax efficient based on the tenure and the type of investment (debt/equity). Having your investments tax efficient can also help you manage with a lower corpus as you don’t have leakage due to income tax. The strategy that you use can be depending on the capital that you have built. Up to your basic exemption limit, you could use investment avenues that are not very tax efficient. You can layer this with more tax-efficient investment options.
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