Most retirement projections are built around an average annual return. Plug in 6%, 7%, or 8%, apply it to your portfolio, add your withdrawal, and the spreadsheet tells you whether the money lasts.
The problem is that you do not retire into an average. You retire into a sequence—one year at a time, in an order no one controls.
When Returns Arrive Matters
When no money is added or withdrawn, the order of a given series of returns does not change the ending value. Two portfolios earning the same returns in reverse order will arrive at the same balance if no cash flows in or out.
Once withdrawals begin, however, poor returns early in retirement may cause disproportionate damage because assets must be sold while the portfolio is depressed. The shares sold to fund spending are no longer available to participate in a recovery.
This is called sequence of returns risk, and it is one of the most consequential variables in a retirement income plan.
A Sequence-of-Returns Illustration
The following comparison is a hypothetical illustration designed to show the effect of return order on portfolio longevity. It uses assumed figures and simplified conditions. Actual results will differ based on taxes, fees, asset allocation, rebalancing, inflation adjustments, and individual circumstances.
Shared Assumptions
- —Starting portfolio: $1,000,000
- —Annual withdrawal: $50,000 (not inflation-adjusted in this illustration)
- —Holding period: 30 years
- —Average annual return: 8% for both portfolios
- —The only difference is the order in which annual returns occur
Jane experiences strong returns in her early retirement years. Her portfolio grows while she withdraws, giving her a buffer against later volatility. After 30 years her terminal balance is approximately $2,744,570 under these assumptions.
John experiences the same returns in reverse order—weak returns in the early years, strong returns later. He must sell assets at depressed prices to meet his withdrawals. Under these assumptions, his portfolio is depleted before year 30, resulting in missed income of approximately $369,900.
Illustrated Difference in Outcomes
The illustrated difference in outcomes—approximately $3.1 million in combined terminal wealth and missed income—reflects return order alone. John did not make a planning error. He faced a risk that is structural to the withdrawal phase of retirement.
This illustration does not constitute a projection or guarantee of any future outcome. It is intended to show how early-period losses can affect a portfolio when withdrawals are ongoing.
Why This Risk Requires a Plan
A financial plan that rests entirely on average return assumptions may underestimate sequence risk. The relevant question is not whether the portfolio earns enough on average—it is whether it can fund spending when markets are down without permanently impairing the remaining balance.
Three planning responses are commonly considered.
An income floor
Income intended to cover essential expenses without depending on current market returns. Social Security, pensions, and certain annuity payments may contribute to this layer. Its primary job is reliability. The plan should also account for how inflation may affect its purchasing power over time.
A resilience reserve
Liquid assets held separately from the growth portfolio to cover near-term spending needs and unexpected expenses. This layer may help you avoid disrupting the growth portfolio when selling investments would be least desirable. The reserve may include cash equivalents, short-duration fixed income, or other conservative assets depending on individual circumstances.
A growth and lifestyle portfolio
The remaining portfolio invested to support inflation, flexible spending, and long-term goals. Because the income floor and reserve reduce dependence on this layer in the short term, it may be invested with a longer time horizon in mind. The allocation should still reflect your risk tolerance, capacity, tax exposure, and survivor needs.
Where Roth Conversions Fit
For some households, the years after retirement and before required minimum distributions begin may provide a favorable opportunity to evaluate intentional Roth conversions. A conversion moves assets from a tax-deferred account, such as a traditional IRA or 401(k), into a Roth account and generally creates taxable income in the conversion year.
Under current law, qualified Roth IRA distributions are generally income-tax-free. Conversions may reduce future required minimum distributions and create greater flexibility in managing taxable income. Whether a conversion is beneficial depends on current and projected tax rates, Medicare premiums, available cash, charitable goals, survivor planning, and your time horizon.
A Roth conversion during a market decline can either increase or reduce long-term planning value depending on how much is converted, where the tax payment comes from, whether market exposure is maintained, and how current tax costs compare with expected future taxes. The conversion should be coordinated with the withdrawal plan rather than evaluated as an isolated tax transaction.
Lower-income years before Social Security or required distributions begin may offer a useful planning window, but they are not automatically the best years for every household. Conversion amounts should be evaluated annually and coordinated with a CPA.
Stress-Testing the Plan
A retirement income plan should account for conditions that differ materially from the base assumption—including the possibility of a significant market decline early in the withdrawal period.
If a significant market decline early in retirement would derail the plan, review:
- —The income floor
- —Cash reserve size
- —Withdrawal level
- —Asset allocation
- —Retirement date
- —Discretionary spending flexibility
A plan that can absorb early market risk through multiple adjustments—not just a single response—is more likely to support income across a long retirement.
The Real Question
A portfolio balance is a starting point. The planning question is what structure allows that balance to fund spending reliably across a retirement that may span 25 to 35 years, through market environments that cannot be predicted.
If you would like to review how your current plan handles sequence risk—and whether your income sources, reserves, and tax strategy are positioned to work together—we can help you think it through.
DISCLOSURE: This information is provided for general educational purposes only. It is not individualized financial, tax, legal, or investment advice. Hypothetical illustrations are based on assumed figures and do not represent the performance of any actual investment. Actual results will differ. Tax treatment depends on individual circumstances and applicable law. Consult a licensed financial professional, CPA, and attorney before implementing a retirement income or tax planning strategy.
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