One of the most common questions I hear from people approaching retirement is:
“How do I turn my savings into a reliable income stream?”
That’s a good question. An even better one is:
“How do I generate income from my investments in a tax-efficient way that doesn’t put my long-term plan at risk?”
Over the past few episodes, I’ve been walking through my three-bucket retirement income approach. Last time we focused on how to invest each bucket. Today we’re going to talk about the other half of the equation — how to actually withdraw money from those buckets once you’re retired.
Building the buckets is only step one. Knowing which bucket to spend from (and when to refill it) is step two. Get this part wrong, and even a well-built plan can start to unravel.
Quick Recap of the Three Buckets
- Bucket 1 – Early Retirement Income Bucket
Money set aside for the next 3–5 years of spending. This bucket prioritizes stability and availability.
- Bucket 2 – Mid-Term Bucket
Money you’ll likely need from roughly years 6 through 20–30. This bucket can take on more growth while still remaining relatively balanced and income-oriented.
- Bucket 3 – Long-Term / Leave-On Bucket
Money you hope you won’t need to spend. This is often the most growth-oriented bucket and may include assets intended for the next generation.
The Core Principle: Spend from Bucket 1 First
Most people get this backwards. They treat their entire portfolio as one big pot and withdraw proportionally from everything.
In the three-bucket approach, the opposite is true. You generally want to spend from **Bucket 1 first**.
Why? Because the early years of retirement carry the highest sequence of returns risk. If the market drops significantly while you’re forced to sell growth investments to cover living expenses, you lock in losses and reduce the number of shares available to recover later. That can create a snowball effect that becomes very difficult to reverse.
Bucket 1 acts as a buffer. When markets are down, you lean on the more stable assets you’ve already set aside. You’re not forced to sell stocks at the worst possible time. This also helps provide additional financial confidence for retirees who are striving to ensure the funds for the next several years of spending are preserved.
Step 1: Spend from Bucket 1
This is the foundation of the strategy. Bucket 1 is intentionally designed to cover near-term spending so you don’t have to touch longer-term investments during a downturn.
In most cases, this is where regular retirement income should come from first.
Step 2: Refill Bucket 1 When Conditions Are Favorable
Spending from Bucket 1 is only half the process. The other half is knowing when and how to refill it.
The goal is to keep roughly three to five years of spending available in Bucket 1 on an ongoing basis. As you draw money out, the bucket naturally shrinks. At some point, it needs to be replenished.
The best time to refill is usually after the market has had a strong period. When Bucket 2 (and sometimes Bucket 3) has grown, you can move money back into Bucket 1 to restore it to your target level.
Discipline matters here. Many people feel uncomfortable taking profits from growth investments even after a good year. Others wait too long and only think about refilling after the market has already dropped. A better approach is to decide on a simple rule in advance — for example: “When Bucket 1 falls below three years of spending and the market has been up for at least a year, we will refill it.”
In practice, most refill money comes from Bucket 2 because of its mid-term time horizon and moderate risk profile. Bucket 3 is usually touched more sparingly, especially when a meaningful portion of it is intended as Leave-On money for heirs.
Some people also use a “slow drip” approach. Instead of making larger annual transfers, they direct the income generated inside Bucket 2 — dividends, bond interest, and other distributions — straight into Bucket 1. This creates a steady, automatic refill over time.
Step 3: Be Intentional with Bucket 3
Bucket 3 is typically the last place you want to draw regular income from.
It has the longest time horizon and often contains a significant amount of Leave-On money — dollars more likely to be passed to children or grandchildren than spent during your lifetime. Taking large or frequent withdrawals from this bucket early can reduce long-term growth potential and may mean spending assets that could have been managed more tax-efficiently for the next generation.
That doesn’t mean you can never touch Bucket 3. Life happens, and there may be years when larger expenses or tax considerations make it appropriate. But the default posture should be protective. The more intentional you are about preserving this bucket, the more flexibility you generally keep later in retirement.
Tax Location Still Matters
Even inside the three-bucket framework, tax location remains important.
As a general guideline (not a one-size-fits-all rule):
1. Spend from taxable accounts first when it makes sense (this is one reason Bucket 1 is often funded with taxable assets).
2. Then look to tax-deferred accounts (traditional IRAs and 401(k)s), which frequently sit in Bucket 2.
3. Try to preserve tax-free accounts (Roth IRAs) as long as possible — these often belong in Bucket 3.
There are exceptions. Sometimes it makes sense to draw from a traditional IRA earlier to manage future RMDs or fill lower tax brackets. Sometimes Roth conversions fit into the picture. This is exactly why a good financial model is so valuable — you can test different withdrawal sequences and see the long-term impact on taxes and probability of success.
Common Mistakes
Here are a few withdrawal mistakes I see regularly:
1. Treating the entire portfolio as one big nest egg and taking a fixed percentage from everything each year.
2. Refusing to touch Bucket 1 because it “feels safe,” then selling stocks during a downturn instead.
3. Never refilling Bucket 1, which eventually forces withdrawals from more volatile investments at the wrong time.
4. Ignoring the tax impact of large withdrawals from tax-deferred accounts (including potential IRMAA surcharges and Social Security taxation).
A Simple Example
Imagine a couple needs $90,000 a year from their portfolio to supplement Social Security. They have about $450,000 in Bucket 1 — roughly five years of spending.
In a normal year, they draw the $90,000 from Bucket 1. After a strong market year, they may move $80,000–$100,000 from Bucket 2 back into Bucket 1 to top it off. If the market is down, they simply continue spending from Bucket 1 and wait for better conditions before refilling.
This approach gives them more control and helps reduce the chance that a bad sequence of returns early in retirement derails their plan.
Final Thoughts
The three-bucket strategy only works well when the withdrawal process is intentional. Building the buckets is step one. Knowing which bucket to spend from — and when to refill it — is step two.
If you’d like to see how this approach might work with your own numbers, I’m currently offering to build your own Smart Retirement Model at no cost or obligation while time slots remain available. You’ll be able to see how different withdrawal strategies could affect your probability of success, your taxes, and what you may be able to leave for the next generation.
You can book a quick 15-minute call at [LeonardiFamilyWealthcare.com](https://www.leonardifamilywealthcare.com). Just look for the Contact and Calendly links.
There really is a smarter way to retire.