Sequence of returns risk is the damage early losses do to a retiree's portfolio when withdrawals force shares to be sold before prices recover. A hypothetical $780,000 portfolio with $24,000 withdrawn each year ends five years later at $626,523 if a 20 percent loss comes first, and at $652,384 if the same returns arrive in reverse.
The decision where this shows up is small and ordinary: you've just left the classroom, the first check from the retirement system hasn't arrived, and you're deciding which account pays for the next twelve months. At Green State Credit Union, advisors look at that choice before the first withdrawal is taken, and they work out the tax effect of each option alongside the investment effect.
By Michael Donovan, AIF — Chief Investment Officer | Reviewed by David Okonkwo, ChFCMichael leads the investment committee, setting strategic asset allocation guidelines and reviewing manager performance quarterly.
If the pension leaves a $24,000 gap, I want two years of it, $48,000, sitting where it can be spent before anyone sells stock funds at a low.
Senior Financial Planner, Green State Credit Union
A reserve inside a pre-tax account doesn't lower the tax; every dollar is still ordinary income, so size withdrawals against your Medicare income tiers.
CPA and Tax Director, Green State Credit Union
Why early losses matter after the school paycheck stops
The order of gains and losses changes nothing while a portfolio sits untouched. Two accounts with the same 5 percent average return end at the same value if nobody adds or removes money. Withdrawals break that tie, because a loss in year one lands on a balance you're already shrinking.
So the average return doesn't tell the whole story. Shares sold at a low price to fund a withdrawal are gone before they can recover, and the rebound then works on a smaller base.
A state pension narrows the gap but rarely closes it. If yours covers the mortgage and groceries, home repairs, health premiums, travel and help for the grandchildren still tend to land on the 403(b) or IRA. A $24,000 per year gap is about 3 percent of a $780,000 balance, and that is the amount a bad first year acts on.
How can the same returns leave different five-year balances?
The same five returns, one 20 percent loss and four 5 percent gains, leave $626,523 when the loss comes first and $652,384 when it comes last. That is a $25,861 gap for a hypothetical $780,000 portfolio with $24,000 withdrawn at the start of each year.
Wanda is 64, widowed, a retired elementary reading specialist with a full pension. Her $780,000 sits across a 403(b), a rollover IRA and an inherited IRA. She needs $24,000 per year from the portfolio before tax; the pension covers the rest of her planned spending.
Loss first: year one, ($780,000 − $24,000) × 0.80 = $604,800. Year two, ($604,800 − $24,000) × 1.05 = $609,840. Year three, ($609,840 − $24,000) × 1.05 = $615,132. Year four, ($615,132 − $24,000) × 1.05 = $620,689. Year five, ($620,689 − $24,000) × 1.05 = $626,523.
Same returns, reversed: year one, ($780,000 − $24,000) × 1.05 = $793,800. Year two, ($793,800 − $24,000) × 1.05 = $808,290. Year three, ($808,290 − $24,000) × 1.05 = $823,505. Year four, ($823,505 − $24,000) × 1.05 = $839,480. Year five, ($839,480 − $24,000) × 0.80 = $652,384. The difference is $652,384 − $626,523 = $25,861.
Now add a reserve. If Wanda sets aside $48,000 ($24,000 × 2 years) in cash that earns nothing, for illustration, and invests the other $732,000, the invested part is $585,600 after the year-one loss and $614,880 after year two. It reaches $620,424 after year three, $626,245 after year four and $632,357 after year five. Her first two withdrawals never touched a low price.
Waiting changes the result. If Wanda carves out the $48,000 only after the drop, she ends near $597,351, because her first two withdrawals were already sold low and the reserve then comes out of a shrunken balance. If she waits five years, all five withdrawals are exposed and she is back at $626,523. Against selling as needed, the reserve's edge here is $5,834, so it's modest in one sequence. Its real job is keeping you from selling at the bottom. Plug your own balance and withdrawal into the site's calculator to see your numbers.
The loss-first sequence and its mirror
Acting now, in two years, or in five
Build the reserve before a decline, not after one
Careful people often wait for a loss before setting aside two years of withdrawals. In Wanda's illustration, two years of delay costs $35,006 ($632,357 against $597,351). The reserve works because it exists before prices fall. Three steps, in order:
A reserve is a spending tool, not a forecast. The rest of the portfolio still needs enough growth to pay for your 80s, so a reserve far larger than two years of gaps trades away growth you'll want later. Your next stop is the Teacher retirement planning page if the pension side is still unsettled.
This isn't a universal target. Skip or shrink it if your pension payments are irregular, you hold plenty of taxable cash already, an inherited IRA deadline is near, or the spending gap will end soon.
Where the reserve should sit
Decision rule: if your pension leaves a recurring portfolio gap, set aside roughly two years of gross planned withdrawals before the first withdrawal, then refill it only after checking taxes and market conditions.
- Find the yearly gap after pension: $24,000 before tax
- Multiply by two for a starting reserve: $48,000
- Hold it inside the account that funds withdrawals when practical
Which taxes change the size of a cash reserve?
Pre-tax 403(b) and traditional IRA withdrawals count as ordinary income in the year you take them, so a $24,000 spending need can require a larger gross withdrawal once tax is withheld. The IRS taxes the whole distribution unless it's Roth money or after-tax basis.
A reserve inside a pre-tax account doesn't make later withdrawals tax-free. It shifts when you sell, not what you owe. What actually lowers the bill is a smaller gross withdrawal, spending less in a down year, or filling low brackets on purpose (a single filer's 2026 standard deduction is $16,100). Roth conversion planning and retirement tax planning cover those moves.
Medicare adds a second threshold. For 2026 the standard Part B premium of $202.90 per month applies at or below $109,000 of single-filer income, and the next tier is $284.10 per month. Medicare sets that tier from an earlier tax year's modified adjusted gross income, so large withdrawals at 63 or 64 can raise premiums later.
Wanda's inherited IRA is the other wrinkle. Her custodian and the beneficiary letter say what distributions are required, and those can add taxable income even when her own spending is already covered elsewhere.
Shifting tax versus saving it
What are the realistic ways to cover the first bad years?
Three approaches cover a bad start: sell investments as needed, hold two years of planned withdrawals in cash and high-quality bonds inside retirement accounts, or cut discretionary withdrawals after a decline. Each changes tax timing, forced sales, flexibility and what stays invested for later decades.
Green State Credit Union bases this on decades of market research and broad diversification. Nobody here guesses what next year's market will do, so the reserve is sized from your spending gap, which is $24,000 a year in Wanda's case.
If the market falls 20 percent, Wanda spends from the reserve and doesn't sell shares at the low. Refilling it later means selling investments and taking more taxable withdrawals, ideally after prices recover. Cutting travel and gifts for a year works differently: she sells fewer shares and reports less taxable income in that same year.
A smaller reserve fits only when the pension covers actual recurring bills. Having a pension isn't enough; a $3,000 per month check that leaves $2,000 per month of bills uncovered still needs reserve.
Comparing the three on the same tests
| Approach | Tax timing | After a 20% drop | Main trade-off |
|---|---|---|---|
| Sell as needed | Ordinary income yearly | Sell lower-priced shares | No reserve drag |
| $48,000 reserve now | Ordinary income yearly | Use reserve first | Less invested initially |
| Cut discretionary withdrawals | Less taxable income | Sell fewer shares | Changes spending plans |
What records should sit beside the withdrawal plan?
Gather the pension payment estimate the retirement system sent you, current 403(b), IRA and inherited IRA statements, the inherited IRA beneficiary letter, your latest Form 1099-R, and a recent federal return. Each document answers a different question. Have all of them on the table before you decide which account pays first.
The pension estimate sets your monthly income floor. Statements show which account holds what. The beneficiary letter gives the inherited-account rules, and the 1099-R plus the return show what was taxable. Then list expected health premiums, home repairs and family support on their own lines, apart from basic bills. Those are usually the withdrawals that turn a small gap into a recurring one.
A downturn can arrive with a health bill or rule change
Markets rarely fall alone. A hospital bill, a pension election that changes after a spouse's death, or a new tax or Medicare rule can arrive in the same year, so leave room to revise withdrawals. All investing carries risk, and your balance can drop below what you contributed. A reserve only buys time; it doesn't promise a recovery.
Questions about sequence of returns risk
Is sequence of returns risk just a reason to keep too much money in cash?
No. A reserve of about two years of withdrawals covers the first bad stretch, and the rest stays invested for growth. In Wanda's hypothetical, the $48,000 reserve improved the five-year result by $5,834. Holding far more cash would cost growth that later years need.
My employer offers a 457(b) alongside my pension, should I hold my cash reserve there?
A governmental 457(b) can work as a reserve account because withdrawals after you leave service generally don't carry the 10 percent early-withdrawal penalty. Withdrawals are still ordinary income. Compare it with your 403(b) on fees, investment choices and how each pays out before deciding.
What does the distribution code on my Form 1099-R mean after I retire?
Box 7 of Form 1099-R holds a code that tells the IRS what kind of payment it was. Code 7 usually means a normal distribution, G a direct rollover, and 4 a payment after the owner's death, which often applies to inherited IRAs. Check it against your return.
Can a Medicare premium notice rise after I take a larger IRA withdrawal during a downturn?
Yes. Medicare sets income-related premiums from an earlier tax year's modified adjusted gross income, so a large withdrawal can raise a later notice. In 2026, income above $109,000 for a single filer moves the Part B premium from $202.90 to $284.10 per month.
Bring one precise withdrawal question to Green State Credit Union
Ask Green State Credit Union: 'Which account would fund my next two years of gross withdrawals, and what taxable income would that create?' Bring the pension estimate, account statements, the inherited IRA letter if it applies, and a recent tax return to the intro call. Green State Credit Union can discuss this with households holding $500,000 in investable assets.
The average return tells you where the portfolio ended only if no one was withdrawing along the way.
Where the rules come from
This is general information, not personalized investment, tax, or legal advice. Investing involves risk, including loss of principal. Before making decisions about your retirement or investments, consult a qualified professional about your own circumstances.