The number. What is my number? Just the thought is like a jolt of adrenalin--the bad kind--the kind you can't turn off. It gnaws at you during the day, and gets your blood rushing in the middle of the night. You can't get away from it. Internet articles pound away at you: Is Retirement Out of Reach? It finds its way into your water-cooler conversations and even creeps into your golf course chit-chat. You know your spouse is thinking of it too, but you don't dare discuss it, not right now--it's too painful, especially in today's 2% world.

These are the thoughts of our clients as they contemplate retirement. They look at their savings and they look at interest rates, and the numbers just don't compute. They need $100,000 in annual income, but alas, they don't have $5 million in cash sitting around. The 8% world they used to know and love is long gone, and it may never return in their lifetime. Today, the golden years seem a lot more like rusty tin. It's daunting. What do I have to give up to make this work? The country club? The vacation home? Winter vacations? Is it even worth trying to retire? Maybe I should just keep working?

The cold, hard fact is that interest rates are about 2%, depending on credit type and maturity. Presently, a 10-year U.S. Treasury bond yields about 3% and the five-year U.S. Treasury note yields 1.6%, while the yield of a AA-rated, five-year municipal bond is in the 1.5% range. For example, a $2 million municipal bond portfolio that averages a 1.5% yield would only generate income of $30,000--plenty if you live in a box, but chump-change if you're in the high-net-worth world. Aside from the ultra-wealthy, living off a 100% bond portfolio is a thing of the past.

What to do? For our clients, we use a "bucket" strategy to generate retirement income. The goal is to produce the cash flow a client needs, yet maintain the client's nest egg through the expected length of his or her lifetime. By breaking down the challenge of generating income into three buckets, each with a defined purpose, we can ease a client's concerns, especially since there is always a bucket of at least one year of income available. Many advisors use some form of a bucket approach to generate income; we use a three-bucket approach because it's easy to execute and you can customize it to a client's needs and temperament.

Essentially, the plan is to create a waterfall of income with three buckets. Pay current income from bucket No. 1, and place funds back in bucket No. 1 at the end of each year (or another opportunistic time) by shifting assets from buckets No. 2 or No. 3.

Here's how you can execute the strategy in just six steps:

1. Annual Income Calculation: Figure how much after-tax annual income the client needs. This is a critical step, since the whole strategy builds from this one number. It's helpful to compute cash needs on an after-tax basis, since then you can more easily evaluate whether you want to use taxable or tax-exempt securities. Be honest about including discretionary items, such as travel--you don't want to unnecessarily short-change the client's lifestyle. At the same time, be reasonable about your assumption for long-term inflation-- it's going to be wrong, so just pick something sensible, like 3.5%. Inflation will be a key variable in step No. 2, the Monte Carlo simulation.

2. Set The Return Parameters: Run a Monte Carlo simulation based on generating the after-tax income needed from both investable assets as well as non-liquid assets such as life insurance. A simulation will give you some sense (certainly not a perfect one) of the investment returns needed to fund retirement. Many of the leading financial planning software programs possess a Monte Carlo simulation module. Some advisors adhere to a certain withdrawal rate, such as 4% or 5%, and those parameters can also be used to shape your income distribution plan.

3. Bucket No. 1: Create a current income bucket invested in very short-term fixed income securities, such as a money market fund, CDs or a weekly reset municipal bond fund. Two years of current income seems to be a reasonable amount, particularly if stock market conditions are favorable. For example, if you need $100,000 per year, place $200,000 (two years of income) into a money market fund. Clients who are more conservative may be more comfortable with three to five years of income in the current income bucket, though the trade-off of more years in bucket No. 1 is less growth potential in the other two buckets.

4. Bucket No. 2: The mid-range bucket should be a conservative income-oriented portfolio, such as a 50% equity/50% bond allocation. This is perhaps the most variable of the buckets. The more conservative the client, the more years of income that should be devoted to this bucket. We believe three to five years of income is reasonable, though more conservative clients may want up to eight years. The goal of this bucket is to provide current income to fund bucket No. 1 and to generate consistent growth in case stock market conditions are challenging and limit the progress of bucket No. 3.

Just a few notes on why we often use a three-year amount of income for bucket No. 2. Combined with the first two years of current income in bucket No. 1, three years of income in bucket No. 2 gives you a total cushion of five years in case market conditions turn weak. Historically, the stock market has done fairly well over five-year periods. Until 2002, the S&P 500 had only two five-year periods of negative performance in the previous 60 rolling five-year periods. Unfortunately, since 2002, the five-year rolling return of the S&P 500 has been negative in five of the past eight years. Although the last eight years have been dismal for the stock market, it's important to maintain perspective: The worst five-year annualized rolling return has been -2.30%. Therefore, even in the worst of five-year periods, the losses are unlikely to be disastrous.

5. Bucket: No. 3: The growth bucket of your portfolio is easy to construct--it's simply the balance of the available assets. This portfolio should have a growth-oriented allocation, such as 80% equity/20% bonds.

6. Continue to Fund Bucket No. 1: Perhaps the most challenging part of this strategy is deciding which bucket to use to fund bucket No. 1. One strategy to consider is that if stocks rise, move assets from bucket No. 3 to bucket No. 1 to rebalance the portfolio. Conversely, if stocks are down, fund bucket No. 1 with bucket No. 2. Depending on market conditions and how you structure the strategy, it's possible that the income from the three buckets will be enough to fund bucket No. 1. As a discipline, it's important to always keep at least one year of income available in bucket No. 1.

With this strategy, you can generate the income you need from Bucket No. 1, generate income and preserve capital with Bucket No. 2, and grow your funds over the long term with Bucket No. 3. Moreover, this strategy is tax-efficient, since a large portion of the funds utilized is often either from money market principal or from sales of stocks with long-term capital gains. Most important, with the bucket strategy, you can help your client sleep more comfortably, knowing that you have a sensible plan for generating income over the long term. Living in a 2% interest rate world raises the bar on the expertise needed to generate income, but as you can see, a little creativity can overcome the market's limitations.

Larry Stein is president of Disciplined Investment Management in Deerfield, Ill. He is author of the book Value Investing: New Strategies for Stock Market Success, and is writing a new book on retirement investing.