The other day the Yahoo Finance daily retirement article had a mention of something covered here many times; one-off expenses. There was also some discussion about health costs, too. This makes a discussion about the bucket theory relevant. Buckets is the idea that is generally attributed to Ray Lucia (I assume he coined the term but am not 100% certain). At our firm we refer to it as the hierarchy of spending, which for us is more about trying to pull from various accounts in the most tax-efficient manner possible, depending on a client's particulars. This really does vary from person to person and I would be cautious of generic advice in a magazine about pulling from an IRA first, second or last.
The bucket strategy seems to be more about time horizon with a short term bucket, a long term bucket and a mid term bucket that serves as a "bridge" between the two. The above linked article got me to wondering if buckets for different objectives as opposed to different time horizons might make more sense. Off the top, three such buckets might be regular monthly expenses, healthcare expenses that are above and beyond and a bucket for one-off expenses above some significant dollar amount. Significant relates to the retiree's budget. Chances are that a $20 one-off could be covered in the normal monthly income but maybe a $1000 one-off would be a different story or for some people maybe $500 is an issue or $2000; whatever is significant.
The normal monthly expenses (including health insurance) are typically the first things that comes to mind with retirement planning. This is lifestyle and reasonably speaking, a huge priority. Some of these expenses haven't been going up much in recent years like maybe the Internet or cable TV. Some have probably gone up a lot like health insurance. Some others are probably pretty volatile; like gas for the car and maybe groceries. We all have our own experiences here but headline inflation has been low for a while so at least some expenses have not gone up a lot.
If you live a $4000 monthly lifestyle in today's dollars before retirement then ideally you probably would hope for something like a $3000-$5000 lifestyle during retirement; $1500 would make for a very difficult adjustment and $10,000 is probably unrealistic. Either way it would be this bucket that would account for most retirement expenses and it would need to produce an income for hopefully a very long time. As the biggest bucket with a slightly more predictable time horizon, this is where a "normal" asset allocation would come into play along with the 4% rule (for those who believe in the 4% rule).
If you have a $4000 lifestyle and believe you will get $2000 from social security then the other $2000/month would come from a $600,000 portfolio (again, if you believe in the 4% or less rule, and I do).
As for health care expenses, this article from MarketWatch offers the unsubstantiated figure that each person will spend $240,000 on health care in retirement. This presumably includes health insurance so guessing $1000/month for 30 years then the $480,000 ($240k x 2) comes down to a $120,000 bucket. Maybe you want to pad that up to $150,000 in case you need an experimental, life-saving cuticle transplant (I make this same joke every time to keep things light).
Going along with this idea, if you have the $150,000 already, then it might be suitable to invest it in TIPs. The downside, of course, is that TIPs track CPI and health-related expenses have been and probably will continue to go up at a faster rate than CPI. An asset allocation here is tricky because the money could be needed very quickly, not for decades or maybe never. One possible allocation strategy would be something "normal" and then if it is ever needed for a costly medical issue, raise a lot of cash so that a large market decline would not threaten paying for treatment.
Not only is picking an asset allocation for a one-off bucket difficult, just guessing how much is needed is difficult. In the past many readers have offered suggestions. Someone once commented $1000/month. That is hopefully too high for month in and month out but some one-off expenses will be in that neighborhood or even more (think home repair, car repair, vet bills as some examples).
If we go with a $500 monthly average and stick with the 30 year assumption noted above, then in today's dollars the amount needed is $180,000. The inflation for these types of expenses seems to have a better chance of being covered by TIPs for someone who has that much.
Someone who is not quite there but who can seed this bucket with some amount of money might want to keep at least a year's worth of one-offs in cash, so in the example above this would be $6000. Keeping a year's worth in cash might seem high but this is money that is expected to be drawn upon regularly. As a general rule, money for any big expense that you know is coming should not be invested in something that can down in value for fear of not being able to go through with the paying for the big expense.
People with enough wealth might also have buckets for travel, helping family (think sandwich generation) or anything else that might come to mind. This entire idea may well be financially beyond most Americans (based on whatever average 401k balance you read about) but is more plausible for people who care enough about investing to read stock market blogs.