Sequence Risk: Why Timing Your Pension Matters More Than You Think
Picture this: You’ve worked hard for decades, built up a solid pension pot, and now you’re ready to enjoy retirement. You’ve planned carefully, expecting your money to last for 20 or 30 years. But what if, right after you start withdrawing, the market takes a dive? Suddenly, your pension pot is shrinking faster than you expected, and even when the market recovers, your savings don’t quite bounce back. This is sequence risk, and it can make or break your retirement plans.
Sequence risk—also known as sequence of returns risk—happens when poor investment returns occur early in retirement, just when you start drawing down your pension. The problem isn’t just market downturns; it’s when they happen. If you hit a bad stretch early on, you could end up withdrawing too much too soon, leaving you with far less money in later years. Let’s break it down in simple terms.
1. How Sequence Risk Works in Pension Drawdown
When you’re still working and saving, market ups and downs don’t impact you as much—your pension pot has time to recover from bad years. But once you retire and start drawing money out, it’s a whole different story. If your investments take a hit early on, while you’re withdrawing money, you’re locking in those losses. Even if markets recover later, your pension pot is already reduced, and it has less time to grow back.
Let’s say you retire with £500,000 and plan to withdraw £20,000 per year. If the market falls 20% in your first year, your pot shrinks to £380,000 after withdrawals. The next year, you still need your £20,000, but you’re withdrawing from a smaller pot, which makes recovery harder. Meanwhile, if someone else experiences a downturn later in retirement—after their pot has grown—they’re in a much better position.
2. Why Sequence Risk is a Big Deal
Sequence risk can have a lasting impact on your retirement income. If markets drop early in your retirement, your savings might not last as long as you had planned. Withdrawing money during a downturn means you lock in losses, making it much harder for your pension to recover. Unlike younger investors, retirees don’t have decades for their portfolios to bounce back. Even if the market performs well later, the damage is often already done.
The bottom line? The timing of market downturns matters just as much as the overall return over your retirement years. If you experience losses early, your retirement savings may be in jeopardy far sooner than expected.
3. Real-Life Example: Two Retirees, Two Different Outcomes
Let’s compare two retirees—John and Sarah—who both retire with £500,000 and withdraw £20,000 per year.
John retires in a year when the stock market crashes by 20%. After his first withdrawal, his pot is already down to £380,000. The next year, the market improves slightly, but he’s still withdrawing from a reduced amount. Over time, these early losses compound, and he runs out of money far earlier than expected.
Sarah, on the other hand, retires in a year when the market grows by 10%. Her pot increases to £530,000 before she takes her first withdrawal. Even when a downturn comes later, she has a larger buffer, meaning she can continue taking withdrawals without significantly impacting her future finances. The same average return, but because the downturn happened later in her retirement, her money lasts much longer.
This is the power of sequence risk—the same overall investment returns but vastly different outcomes based on when bad years occur.
4. How to Reduce Sequence Risk in Your Pension Drawdown
The good news? You can take steps to protect yourself from sequence risk so you don’t run out of money too soon.
One of the most effective strategies is to keep a cash reserve. By holding one to three years’ worth of expenses in cash, you can avoid selling investments at a loss when markets are down. Instead of withdrawing from your pension in a bad market year, you can use your cash reserve to cover expenses and wait for your investments to recover before resuming withdrawals.
Another way to reduce sequence risk is by using a dynamic withdrawal strategy. Instead of taking the same fixed amount each year, you adjust withdrawals based on market performance. When the market is strong, you withdraw slightly more, and when it’s down, you cut back. This flexibility ensures that you’re not depleting your pension pot too quickly in bad years.
Delaying withdrawals, if possible, can also be a powerful tool. If you have other sources of income, such as rental income or part-time work, relying on these instead of your pension in the early years can allow your pot to continue growing before you start drawing from it.
Diversifying your investments is another key strategy. A pension pot that’s entirely invested in stocks is far more vulnerable to sequence risk than one that has a mix of stocks, bonds, and cash. Having a well-balanced portfolio means that even in market downturns, you have safer assets to draw from, rather than being forced to sell stocks at a loss.
For those who want absolute certainty in their retirement income, purchasing an annuity can provide stability. An annuity guarantees a set income for life, meaning part of your retirement income is protected from market fluctuations. While annuities may not provide as much long-term growth as investments, they can offer peace of mind and reduce reliance on volatile pension drawdown strategies.
Finally, working with a financial advisor can help you develop a personalised withdrawal plan that balances growth and security, ensuring that your money lasts throughout retirement.
Key Takeaways: Making Your Pension Last
Sequence risk isn’t about how much you earn overall, but when bad years happen. A downturn early in retirement is far more dangerous than one later on. If you withdraw from a shrinking pot, you lock in losses, making it much harder for your pension to recover.
Using strategies like keeping cash reserves, adjusting withdrawals based on market performance, diversifying your investments, and considering annuities can all help reduce the impact of sequence risk. The key is to be flexible and prepared. If markets drop early in your retirement, having a plan in place can prevent you from making withdrawals that permanently damage your financial future.
Retirement should be about enjoying life, not stressing over market fluctuations. By understanding sequence risk and planning ahead, you can make sure your pension works for you, no matter what the market does.
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- What is a Dynamic Withdrawal Strategy in Pension Drawdown? - February 24, 2025
Peter is an expert in the financial services sector, having formerly been a independent financial advisor (IFA) in London for over 10 years and completing his FFA FIPA in 2023, he now helps run Pension Drawdown Calculator helping retirees and soon to be retirees calculate their pension savings.
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