The 3 Bucket Strategy: Roth, Traditional, & After-Tax Brokerage

The 3 Bucket Retirement Strategy is a powerful method that divides your savings into three categories based on how they’re taxed: tax-free, tax-deferred, and taxable. Structured around tax diversification, this approach gives you greater control over your retirement income, allowing you to adapt to changing tax laws and reduce what you owe. It’s a forward-looking way to ensure more of your money works for you.

TL;DR: The 3 Bucket Strategy

• The 3 Bucket Strategy organizes your savings by how they are taxed: tax-free, tax-deferred, and taxable.
• The goal is tax diversification, which gives you more control and flexibility over your retirement income and helps you adapt to changing tax laws.
• Bucket 1 (Tax-Free): Includes Roth IRAs and Roth 401(k)s. You contribute after-tax money, and qualified withdrawals in retirement are tax-free.
• Bucket 2 (Tax-Deferred): Includes Traditional IRAs and 401(k)s. Contributions are pre-tax, potentially giving you an upfront tax deduction, but withdrawals are taxed as income in retirement.
• Bucket 3 (Taxable): Includes regular brokerage and savings accounts. You contribute after-tax money and pay taxes on gains, but there are no age limits for withdrawals, offering high flexibility.
• A common withdrawal strategy in retirement is to draw from taxable accounts first, then tax-deferred, and finally Roth accounts to allow the tax-advantaged funds to grow longer. However, this can be adjusted annually to optimize for taxes.

What is the Three Bucket Strategy?

The 3 Bucket Strategy is a way to organize your retirement savings based on how they’re taxed. Rather than focusing on when you’ll use the money or how risky the investments are, this method groups your accounts into three types: tax-free, tax-deferred, and taxable. 

Each bucket has a different role in retirement. One might offer upfront tax perks, another gives tax-free withdrawals later, and the third provides more flexibility. Think of it like spreading out your risk, but for taxes instead of investments. 

The Importance of Tax Diversification in Retirement Planning

Tax diversification means having a mix of accounts that are taxed in different ways. It’s a beneficial strategy because no one knows what future tax rates will be, or how your income needs may change in retirement. 

Spreading your savings across different tax categories lets you decide where to take money from each year. This gives you more control over your income, manages required minimum distributions (RMDs), and might lower things such as Medicare premiums. It’s a simple way to keep more of your retirement income in your pocket. 

The three-bucket strategy works best when paired with a smart diversification plan that mixes asset types, regions, and risk levels to bring more balance to your Roth, traditional, and after-tax brokerage accounts.

Breaking Down the 3 Buckets

Each of the three buckets plays a different role in your retirement plan. Understanding what goes into each one ensures you make better choices about how to save and where to draw money from later. 

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Bucket 1: The Tax-Free Bucket (Roth IRA & Roth 401 (k))

This bucket includes accounts such as Roth IRAs and Roth 401(k)s. You pay taxes on the money before contributing, but qualified withdrawals in retirement are tax-free. 

You can contribute to a Roth IRA if you meet certain income limits. Roth 401(k)s don’t have income limits, but both types have annual contribution caps. 

Tax-free growth is one of the most significant benefits. There are no required RMDs for Roth IRAs, and these accounts are helpful for passing money on to heirs. This bucket typically works well for younger investors, high earners who expect higher taxes later, and people focused on long-term legacy planning. 

Since Traditional and Roth IRAs are key components of the tax-deferred and tax-free “buckets,” understanding how they work is essential for building a balanced retirement strategy. See our article on Individual Retirement Accounts (IRAs).

Bucket 2: The Tax-Deferred Bucket (Traditional IRA & 401(k))

This bucket covers traditional retirement accounts where contributions are made pre-tax. You don’t pay taxes up front, but you do when you withdraw money in retirement. 

These accounts follow RMD rules starting at age 73, and they have yearly contribution limits. One benefit is that you may receive a tax deduction when you contribute. 

This setup is useful if you think you’ll be in a lower tax bracket later on. It’s also common for people who have employer-sponsored plans or are in their peak earning years. 

Discover how IRAs differ from 401(k)s regarding taxes, access, and flexibility so you can allocate the right accounts to the right buckets.

Bucket 3: The Taxable Bucket (After-Tax Brokerage Accounts)

The taxable bucket includes regular brokerage and savings accounts. You invest after-tax money here and pay taxes on dividends, interest, and any capital gains when you sell investments. 

Even though these accounts don’t offer tax perks like the others, they’re more flexible. You can use the money at any time without penalties, which makes it ideal for early retirement or emergencies.

Taxable accounts also play a role in estate planning and tax-loss harvesting, where you sell investments at a loss to offset gains elsewhere. 

Why Use the Three Bucket Strategy?

The 3 Bucket Strategy gives you more options in the future. No one can predict future tax laws or market shifts, so having money spread across all three types of accounts is wise.

This setup makes it easier to decide which bucket to draw from each year. You can lower your taxable income, reduce the impact of RMDs, and avoid jumping into a higher tax bracket. It can also aid in managing Medicare costs and leave more to your heirs if that’s something you choose to do. 

How to Allocate Across the Buckets

There’s no single mix that works for everyone, but the way you divide your savings across the three buckets shapes how much flexibility you have in retirement. Your age, goals, and income all play a role. A financial planning approach can tailor the breakdown to your situation. 

Conservative, Moderate, and Aggressive Allocation Examples

A conservative allocation may be 25% tax-free, 45% tax-deferred, and 30% in taxable accounts. This approach leans on tax-deferred savings while keeping some flexibility in taxable and tax-free buckets. 

A moderate setup could be more balanced, something like 33% in each. An aggressive strategy may focus more on Roth accounts early, particularly for younger investors who expect to be in a higher tax bracket later. 

How Life Stage Affects Your Allocation

Your ideal mix can change over time. In your 20s or 30s, you might focus more on Roth contributions to lock in tax-free growth. By mid-career, tax-deferred accounts like a traditional 401(k) might take precedence.

If you’re 50 or older, catch-up contributions and Roth conversions become more relevant. Once you’re near retirement, having accessible funds in a taxable account bridges the gap before RMDs or Social Security come into play. 

See how your savings stack up with our article on the Average Net Worth by Age.

Factors That Influence the Right Mix for You

Everyone’s situation is different. Your future tax bracket, how stable your income is, when you want to retire, and if you want to leave money to your family all affect how you spread your savings. 

For example, someone expecting big swings in income may lean more on Roth accounts. If you’re aiming to retire early, a larger taxable bucket could be useful. The best mix boils down to what fits your goals, not simply general advice. 

Putting the Strategy to Work: Contributions and Withdrawals

Once your buckets are set up, the next step is figuring out how to fund them and how to take money out when the time comes. A good plan considers both sides so your savings last longer and work harder for you in retirement. 

Prioritizing Contributions Across Buckets

Begin by ensuring you bet any employer match in your 401(k). That’s free money. After that, many people contribute to a Roth account for the tax-free growth. Once that’s full, you can keep going with traditional accounts and then taxable ones. 

Some people also use strategies like the mega backdoor Roth to move more money into tax-free accounts. At the same time, keeping some money in a taxable account builds flexibility for short-term needs or early retirement. 

Sequencing Withdrawals for Tax Efficiency

In retirement, a common withdrawal order looks like: taxable → tax-deferred → Roth. This lets your tax-advantaged accounts grow while using the more flexible money first. 

However, that’s not a hard rule. If you have a year with lower income, you might pull from tax-deferred accounts to take advantage of a lower tax bracket. The idea is to plan withdrawals in a way that keeps your taxes as low as possible over time. 

Dynamic vs. Proportional Withdrawal Approaches

With dynamic withdrawals, you adjust how much and where you pull from each year based on your income and market performance. With a proportional approach, you take the same percentage from each bucket. 

Dynamic methods grant you more control but require more planning. Proportional methods are simple but might not be as tax-friendly. You don’t have to figure this out alone. Many people use tools or work with an advisor to guide the process. 

Ways to Fine-Tune Your Bucket Strategy

Once you’ve got the basics down, there are a few extra strategies that can get you even more out of your buckets. These approaches aren’t required, but they can be beneficial, especially if you’re planning ahead or working with an advisor. 

Roth Conversions During Low-Income Years

If you expect your income to drop temporarily, consider converting some traditional IRA or 401(k) money into a Roth account. 

You’ll pay taxes on the amount you convert, but you’ll avoid higher taxes on that money later. This move lowers future RMDs and grows your tax-free bucket. Timing matters, though, so it’s worth running the numbers or seeking advice on the decision. 

Tax-Loss Harvesting in Taxable Accounts

If your taxable investments lose value, you may be able to sell them to offset gains elsewhere. This is called tax-loss harvesting, and it lowers your tax bill for the year. 

It works well with funds in your taxable bucket, especially if you’re doing regular rebalancing. Just be careful about the wash-sale rule. It can prevent you from claiming a loss if you repurchase the same investment too soon. 

Asset Location: Placing the Right Investments in the Right Buckets

Not every investment is taxed the same way, so where you hold them matters. Tax-inefficient assets such as bonds and REITs (Real Estate Investment Trust) are generally better off in tax-advantaged accounts. More tax-efficient assets like index funds or ETFs (Exchange-Traded Fund) can go into your taxable account.

This kind of planning, called asset location, can lower your overall taxes without changing what you invest in. 

Mistakes to Watch Out For

Even with a solid plan, it’s easy to overlook a few things when managing your buckets. Paying attention to common missteps saves you trouble later and keeps your strategy on track. 

One mistake is focusing too much on avoiding taxes and not enough on having money available when you need it. It’s also easy to forget about rebalancing or to skip updating your plan as your life changes. 

Some people rely only on tax-deferred accounts, which leads to large RMDs later. Others don’t think about how their plan fits into estate planning. 

The good news? These are all fixable. Checking in on your mix regularly and thinking about both short-term term needs and long-term goals keeps everything running well. 

Is the Three Bucket Strategy Right for You?

This strategy is meant to give you more choices later on. If you want more flexibility with your retirement income and more control over your taxes, the 3 Bucket Strategy could be a great fit for you. 

Key Takeaways:

• The 3 Bucket Strategy groups your savings by how they’re taxed: tax-free, tax-deferred, and taxable.
• Each bucket plays a different role in retirement and offers unique benefits.
• Tax diversification makes it easier to manage withdrawals, avoid big tax bills, and handle unexpected changes. 
• Your age, goals, income, and tax bracket all influence how you should allocate.
• There are simple and experienced ways to make the most of your buckets over time.

Action Items:

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Ready to build a tax-efficient retirement? A Savvy advisor can help you apply the 3 Bucket Strategy to your unique financial situation. Schedule a consultation today to optimize your savings and secure your future.

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Key Terms to Know

• Required Minimum Distributions (RMDs): The minimum amount you must withdraw annually from most retirement accounts, like Traditional IRAs and 401(k)s, starting at age 73. Roth IRAs are exempt.
• Tax-Loss Harvesting: A strategy used in taxable accounts where you sell investments at a loss to offset capital gains taxes on other investments.
• Roth Conversion: The process of moving funds from a tax-deferred account (like a Traditional IRA) to a tax-free Roth account. You pay income tax on the converted amount in the year of the conversion.
• Asset Location: The strategy of placing different types of investments into the most tax-efficient accounts. For example, placing tax-inefficient bonds in tax-advantaged accounts.

FAQs

Does the bucket strategy work?

Yes, it’s widely used because it balances tax flexibility, withdrawal planning, and investment control. It gives retirees options to adapt to tax laws, income changes, and market swings.

What is the best withdrawal strategy for retirement?

There’s no one-size-fits-all. Many start with taxable accounts, then use tax-deferred, saving Roth funds for later—but smart retirees adjust yearly to minimize taxes.

What is the percentage of the 3 bucket strategy?

There’s no fixed rule, but some examples include 33/33/33 or 25/45/30 across tax-free, tax-deferred, and taxable buckets. The ideal mix depends on your age, income, and goals.

Which bucket do I draw from first?

Often, people tap taxable accounts first to allow tax-advantaged ones to keep growing. But it can change year-to-year depending on your income and tax bracket.

What are the three bucket tax strategies?

They include tax diversification (spreading assets across all three), tax-smart withdrawals, and strategic asset placement to reduce taxes over time.

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