The Bucket Strategy for Retirement Income in New Zealand

Picture this: you retire in January. By March, the sharemarket has dropped 15%. Your retirement savings, built over 40 years, are suddenly worth significantly less. Do you sell investments to cover your living costs, or do you panic?

This nightmare scenario keeps many near-retirees awake at night. It's also exactly why the bucket strategy has become one of the most popular retirement income approaches worldwide, and why it's particularly well-suited to New Zealand's retirement landscape.

The bucket strategy is a mental accounting framework that divides your retirement savings into three distinct pools (or 'buckets'), each designed to fund different timeframes of your retirement. The beauty of this approach is its simplicity: it gives you a clear plan for where next month's grocery money comes from, while still letting the bulk of your savings grow for the decades ahead.

The bucket strategy organizes your retirement assets based on when you'll need to access them. Each bucket has a different job, a different investment approach, and a different level of risk.

Bucket 1: Your Cash Buffer (Years 1-2)

This bucket holds your short-term spending money in conservative, easily accessible investments. Think of it as your financial shock absorber. For most New Zealand retirees, this means:

• Everyday savings accounts
• Term deposits (ranging from on-call to 12-month terms)
• Conservative PIE funds with very low volatility
• Cash management accounts

The typical size of this bucket is 1-3 years of expenses that aren't covered by NZ Super. If you're a couple receiving around $46,000 annually from NZ Super (after tax) and need $70,000 total to live comfortably, your Bucket 1 might hold $24,000-$72,000.

Bucket 2: Your Medium-Term Reserve (Years 3-10)

This bucket bridges the gap between immediate needs and long-term growth. It typically holds:

• Balanced PIE funds (mix of shares and bonds)
• Conservative to moderate managed funds
• Longer-term fixed income investments
• Some exposure to growth assets, but with more stability than pure share funds

This bucket aims to generate modest growth while remaining relatively stable. Historical returns for balanced funds in New Zealand have typically ranged from 4-7% annually over 10-year periods, though past performance doesn't guarantee future results.

Bucket 3: Your Long-Term Growth Engine (Years 11+)

This bucket holds your most growth-oriented investments because you won't need this money for over a decade. It typically includes:

• Growth or aggressive PIE funds
• KiwiSaver (if you haven't fully withdrawn it)
• International and domestic share funds
• Property investments

The goal here is capital growth. You're not touching this money for years, which means you can ride out market volatility. Over the 20-year period ending December 2023, the NZX50 has delivered average annual returns around 9-10%, though with significant year-to-year variation.

Here's where the New Zealand retirement landscape differs significantly from countries like the United States or Australia: NZ Super is universal, unfunded from prior contributions, and relatively generous compared to many international pension systems.

For a couple, NZ Super currently provides around $46,000 annually (after tax). For a single person living alone, it's around $28,000. This government-funded income stream fundamentally changes how you apply the bucket strategy.

NZ Super as Your Foundation Bucket

Many financial commentators describe NZ Super as an invisible 'Bucket Zero', a guaranteed income stream that covers your baseline expenses. According to Statistics New Zealand's Household Economic Survey, the average retired couple spends around $61,000-$70,000 annually.

If NZ Super covers $46,000 of that, you only need to fund $15,000-$24,000 per year from your savings. This dramatically reduces the size of your cash buffer. Instead of needing $140,000 in Bucket 1 to cover two years of full expenses, you might only need $30,000-$48,000 to cover the gap.

This is a massive advantage. It means more of your savings can remain invested for growth, and you're less vulnerable to the timing of market downturns in early retirement (what financial planners call sequence of returns risk).

The KiwiSaver Consideration

Most New Zealanders reach 65 with their KiwiSaver intact. You can withdraw your entire KiwiSaver balance at age 65, or leave it invested and draw down gradually. This flexibility creates interesting options for bucket planning:

• Use KiwiSaver to fill Bucket 1 and 2 completely, leaving other investments for Bucket 3
• Keep KiwiSaver as your Bucket 3, continuing to benefit from the same fund management and PIE tax treatment you've had for decades
• Split your KiwiSaver across buckets, moving some to conservative funds (Bucket 1) while keeping the rest in growth (Bucket 3)

There's no single right answer. The key factor is whether your KiwiSaver provider offers the flexibility and fund options you need. Some providers excel at retirement income solutions; others are built primarily for accumulation.

Portfolio Investment Entities (PIE funds) are specifically designed to be tax-efficient for New Zealand investors. Unlike standard managed funds, PIE funds pay tax at your Prescribed Investor Rate (PIR), which is capped at 28%, even if your marginal tax rate is higher.

For retirees, this structure offers real advantages. If you're living on NZ Super plus modest withdrawals from savings, your actual income might place you in the 17.5% or 28% PIR bracket. According to the Inland Revenue guidance on PIR rates, you can use the 17.5% rate if your taxable income in either of the last two tax years was $48,000 or less (and your total taxable income plus PIE income was $70,000 or less).

Here's a practical example: if you earn $10,000 in investment returns from a PIE fund and your PIR is 17.5%, you'll pay $1,750 in tax. The same return in a standard managed fund might be taxed at 33% if your marginal rate is higher, costing you $3,300. That's $1,550 more staying in your bucket.

PIE funds work particularly well for Buckets 2 and 3, where you're holding investments for medium to long-term growth. Many New Zealand fund managers offer PIE-structured versions of their balanced and growth funds, making this tax advantage accessible without complicated restructuring.

Implementing a bucket strategy isn't about following a rigid formula. It's about building a framework that matches your specific situation. Here's how to think through the process:

Step 1: Calculate Your Annual Funding Gap

Start by figuring out how much you need to withdraw from savings each year:

• Total annual living expenses (be realistic, not optimistic)
• Minus: NZ Super (after tax)
• Minus: any other guaranteed income (rental property, part-time work, annuities)
• Equals: your annual funding gap

This number determines how much you'll withdraw from your buckets each year.

Step 2: Size Your Cash Buffer (Bucket 1)

Factors to consider when deciding on 1, 2, or 3 years of expenses:

• Your comfort level with market volatility (honest self-assessment matters here)
• Whether you have flexibility to reduce spending temporarily if needed
• Your age and health (closer to life expectancy might mean a smaller buffer)
• Current market valuations (starting retirement at market peaks historically has increased the value of larger cash buffers)

A couple with a $20,000 annual funding gap might hold $40,000-$60,000 in Bucket 1. This buys them 2-3 years of financial breathing room.

Step 3: Allocate Your Medium and Long-Term Buckets

Once you've set aside your cash buffer, divide the remainder between growth and stability based on:

• Total portfolio size (larger portfolios can often handle more in Bucket 3)
• Your time horizon (planning for 30+ years of retirement versus 15 years)
• Other assets you haven't included in the bucket system (family home, investment property)
• Your capacity to return to work or reduce expenses if things go wrong

A common starting framework might be 30-40% in Bucket 2 and 60-70% in Bucket 3, but this varies widely based on individual circumstances.

Step 4: Choose Your Investment Vehicles

Match your buckets to appropriate investments:

• Bucket 1: Bank accounts, term deposits (consider spreading across banks for deposit guarantee scheme coverage), conservative PIE funds
• Bucket 2: Balanced PIE funds, conservative managed funds, potentially some bond funds
• Bucket 3: Growth PIE funds, your KiwiSaver (if left invested), share funds, growth managed funds

PIE funds deserve strong consideration across all buckets due to their tax efficiency.

The bucket strategy isn't a set-and-forget system. It requires periodic maintenance, specifically refilling Bucket 1 as you draw it down.

The standard approach is annual rebalancing. Once a year (many people choose their birthday or the start of the tax year), you:

1. Review how much you've withdrawn from Bucket 1 over the past year
2. Look at the performance of Buckets 2 and 3
3. Transfer money from Bucket 2 to Bucket 1 to restore your cash buffer
4. If Bucket 2 has performed well, transfer money from Bucket 3 to Bucket 2

This creates a one-way flow in normal times: Bucket 3 → Bucket 2 → Bucket 1 → Your spending.

The clever part is what happens during market downturns. If shares have fallen significantly, you might skip the Bucket 3 to Bucket 2 transfer that year. Instead, you let Bucket 2 refill Bucket 1, giving your growth investments time to recover without forcing you to sell at a loss.

This is precisely how the bucket strategy protects against sequence risk. You're not selling shares in a bear market to fund your groceries. You're living off the cash you set aside specifically for this scenario.

Some retirees prefer more frequent rebalancing (quarterly or even monthly), particularly if they're hands-on investors who enjoy the process. Others work with financial advisers who handle this systematically. There's no perfect frequency; what matters is having a consistent process you'll actually follow.

Mistake 1: Keeping Too Much in Cash

The biggest risk for New Zealand retirees isn't market crashes; it's outliving your money. When you hold 5+ years of expenses in cash earning 2-3% while inflation runs at 3-4%, you're guaranteeing the loss of purchasing power.

With NZ Super providing a foundation, most retirees don't need enormous cash buffers. Two years is typically adequate; three years is conservative. Beyond that, you're likely sacrificing too much growth potential.

Mistake 2: Forgetting About Inflation

Your buckets need to grow over time, not just maintain their nominal value. If you retire at 65 and live to 95, your expenses in year 30 will be dramatically higher than year 1, even if your lifestyle doesn't change.

This is why Bucket 3 matters so much. It's not just backup money; it's your inflation protection. The growth assets in Bucket 3 have historically outpaced inflation over long timeframes, which is exactly what you need for a 30-year retirement.

Mistake 3: Treating Buckets as Completely Separate

The buckets are a mental framework for managing withdrawals and volatility, not legally separate accounts that must never interact. You might need to adjust bucket sizes as your circumstances change:

• Major health expenses might require temporarily drawing from Bucket 2 or 3
• An inheritance could flow into Bucket 3 to boost growth potential
• Downsizing your home might refill all three buckets at once

Flexibility is a feature, not a bug. The framework guides your decisions; it doesn't imprison them.

Mistake 4: Ignoring Tax Planning

Different buckets can have different tax treatments. Term deposit interest is taxed as income. PIE fund returns use your PIR. Understanding which bucket you're withdrawing from can influence your annual tax position.

This complexity is exactly why many retirees work with financial advisers, particularly in the first few years of retirement when you're establishing your withdrawal patterns. The bucket strategy itself is simple, but optimizing the implementation can get technical.

The bucket strategy isn't the only way to manage retirement income. Some alternatives include:

• Systematic withdrawal plans (selling a fixed percentage of your portfolio each year)
• The guardrails approach (adjusting spending based on portfolio performance)
• Annuities or other guaranteed income products
• Dynamic withdrawal strategies that respond to market conditions

The bucket strategy tends to work well for people who:

• Value psychological comfort and want to see their short-term spending money clearly separated from long-term investments
• Are concerned about market volatility in early retirement
• Prefer a systematic, rules-based approach to withdrawals
• Have sufficient assets to meaningfully divide across three timeframes (typically $200,000+ in addition to NZ Super)

It's less necessary for people who:

• Have very large portfolios relative to spending (where sequence risk is minimal)
• Are comfortable with high portfolio volatility and don't need the psychological buffer
• Prefer simpler approaches and are willing to adjust spending in down markets

For many New Zealand retirees, particularly those transitioning from the accumulation phase into actually living off their savings, the bucket strategy provides a valuable mental framework. It answers the scary question ("what happens if the market crashes the day I retire?") with a concrete plan ("I'll live off my cash buffer while waiting for recovery").

This article is general information only and does not constitute personalised financial advice. For advice tailored to your situation, speak with a licensed Financial Advice Provider. You can find a registered adviser at fma.govt.nz.