What is sequencing risk in pension drawdown?

Full answer

Sequencing risk (also called sequence-of-returns risk) is one of the most important, and most commonly underestimated, risks facing people who use pension drawdown to fund their retirement. **Why the order of returns matters, not just the average** During the pension saving (accumulation) phase, the order in which investment returns occur does not matter much to your final pot size -- only the average return over the whole period matters, since you are not withdrawing money along the way. During drawdown, however, you are simultaneously withdrawing income while your remaining pot stays invested -- if a market downturn happens early in your retirement, you are forced to sell a larger number of investment units to generate the same income, permanently reducing the capital left to benefit from any later market recovery. **A simplified illustration** Two retirees have identical average investment returns over a 20-year retirement, but experienced them in a different order. Retiree A experiences poor returns in the first few years of retirement, then strong returns later. Retiree B experiences the same returns in reverse order -- strong first, poor later. Despite having the same average return overall, Retiree A can run out of money significantly sooner than Retiree B, purely because of when the poor returns occurred relative to their withdrawals. **Why this matters more in drawdown than during saving** Sequencing risk is largely irrelevant if you are not withdrawing money (during your working years, contributions can even benefit from buying more units cheaply during a downturn) -- it becomes a serious risk specifically once you start taking a regular income from an invested pot, which is exactly the situation many retirees using flexi-access drawdown are in. **Ways to manage sequencing risk** Common strategies include holding one to three years of income needs in cash or lower-risk assets to avoid being forced to sell volatile investments during a downturn, taking a flexible rather than fixed withdrawal rate (reducing withdrawals in years following poor returns), using a "bucket" strategy that separates short-term income needs from longer-term invested growth assets, or using an annuity for essential income needs to remove this risk entirely for at least part of your retirement income. **Worked example** A retiree withdraws a fixed £20,000 a year from a £400,000 pot. If the market falls 20% in year one, their pot drops to roughly £304,000 before the following year's withdrawal is even taken out -- a much larger effective withdrawal rate on the remaining pot than originally planned, which can compound the damage if poor returns continue. **Practical tip** Use the Pension Drawdown calculator to model different withdrawal strategies and return sequences, and consider discussing sequencing risk specifically with a regulated financial adviser before committing to a fixed drawdown income in retirement.

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