Sequence of Returns Risk: Why the First Few Years of UK Retirement Matter Most

You can plan a retirement around solid average returns and still run out of money if those returns arrive in the wrong order. That is sequence of returns risk, and it is one of the most underappreciated threats to anyone drawing down a pot in the UK. Here is how it works and how to soften it.

The order of returns matters, not just the average

While you are saving, a market crash is almost helpful: your regular contributions buy more units cheaply. Once you start withdrawing, the maths flips. A crash early in retirement forces you to sell more units to fund the same spending, and those units are gone for good. Even if the market later recovers, the pot may be too depleted to bounce back.

Two retirees can experience the exact same average return over 30 years and end up in completely different places, purely because of when the bad years hit.

A worked example

Imagine two retirees, each starting with GBP 500,000 and withdrawing GBP 20,000 in year one (the 4 percent rule), rising with inflation. Both experience the same set of annual returns - just in opposite order.

• Retiree A gets two sharp falls in years one and two, then a long recovery.
• Retiree B gets the long recovery first and the two falls near the end.

Although their average return is identical, Retiree A sells units at depressed prices early on. By the time markets recover, the pot has far fewer units left to grow. Retiree A can run short decades later, while Retiree B sails through. Same average, very different outcome.

Practical ways to cushion it

You cannot control market timing, but you can build defences:

• Hold one to three years of spending in cash or short-dated savings, so a fall does not force a sale.
• Keep flexible ISA money you can draw on instead of selling shares in a downturn.
• Trim discretionary spending after a bad year, then restore it when markets recover.
• Start with a slightly lower withdrawal rate, such as 3 to 3.5 percent, for a long early retirement.

Why ISAs are useful here

ISA flexibility is a quiet superpower for managing sequence risk:

• Withdrawals are free of Income Tax and Capital Gains Tax.
• A flexible ISA lets you withdraw and replace within the same tax year, up to the GBP 20,000 allowance, so a cash buffer held in an ISA does not waste your allowance permanently.
• Drawing tax-free ISA cash in a bad year avoids crystallising taxable gains or pension income you do not need.

It applies to pensions too

The same risk hits flexible pension drawdown. A market fall in the first years of taking pension income can do lasting damage. Keeping a cash buffer inside or alongside the pension, and being willing to flex the income you take, protects the pot during the dangerous early window. Remember pension income above the Personal Allowance of GBP 12,570 is taxable, so flexing withdrawals also helps manage your tax.

The takeaway

Average returns hide the danger. The first five to ten years of withdrawals decide much of the outcome, so build buffers, stay flexible, and avoid being a forced seller in a downturn.

To stress-test different withdrawal rates and starting pots, try the CalcHub FIRE and compound interest calculators, and read the pension drawdown guidance at gov.uk before you set your plan.