• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Evergreen Small Business

Actionable Insights from Small Business CPAs

  • Home
  • Small Business FAQ
  • Monographs
    • Maximizing PPP Loan Forgiveness
    • Preparing U.S. Tax Returns for International Taxpayers
    • Maximizing Sec. 199A Deductions Monograph
    • Setting Low Salaries for S Corporations
    • Small Business Tax Deduction Secrets
    • Real Estate Tax Loopholes & Secrets
    • Preparing Form 3115 for the Tangible Property Regulations
    • Small Businesses and the Affordable Care Act (Obamacare)
    • Five Minute Payroll Monograph (2019 Edition)
    • Download Your Free Copy of the Thirteen Word Retirement Plan
    • Business Planning Workbook
    • Sample Corporate Bylaws
    • LLC Operating Agreement
    • Joining Our Affiliate Program
  • Our Bloggers
  • Free LLC Formation Kits
    • Alabama LLC
    • Alaska LLC
    • Arizona LLC
    • Arkansas LLC
    • California LLC
    • Colorado LLC
    • Connecticut LLC
    • Delaware LLC
    • Florida LLC
    • Georgia LLC
    • Hawaii LLC
    • Idaho LLC
    • Illinois LLC
    • Indiana LLC
    • Iowa LLC
    • Kansas LLC
    • Kentucky LLC
    • Louisiana LLC
    • Maine LLC
    • Maryland LLC
    • Massachusetts LLC
    • Michigan LLC
    • Minnesota LLC
    • Mississippi LLC
    • Missouri LLC
    • Montana LLC
    • Nebraska LLC
    • Nevada LLC
    • New Hampshire LLC
    • New Jersey LLC
    • New Mexico LLC
    • New York LLC
    • North Carolina LLC
    • North Dakota LLC
    • Ohio LLC
    • Oklahoma LLC
    • Oregon LLC
    • Pennsylvania LLC
    • Rhode Island LLC
    • South Carolina LLC
    • South Dakota LLC
    • Tennessee LLC
    • Texas LLC
    • Utah LLC
    • Vermont LLC
    • Virginia LLC
    • Washington LLC
    • West Virginia LLC
    • Wisconsin LLC
    • Wyoming LLC
  • S Corporation Kits
    • Alabama S Corporation
    • Alaska S Corporation
    • Arizona S Corporation
    • Arkansas S Corporation
    • California S Corporation
    • Colorado S Corporation
    • Connecticut S Corporation
    • Delaware S Corporation
    • Florida S Corporation
    • Georgia S Corporation
    • Hawaii S Corporation
    • Idaho S Corporation
    • Illinois S Corporation
    • Indiana S Corporation
    • Iowa S Corporation
    • Kansas S Corporation
    • Kentucky S Corporation
    • Louisiana S Corporation
    • Maine S Corporation
    • Maryland S Corporation
    • Massachusetts S Corporation
    • Michigan S Corporation
    • Minnesota S Corporation
    • Mississippi S Corporation
    • Missouri S Corporation
    • Montana S Corporation
    • Nebraska S Corporation
    • Nevada S Corporation
    • New Hampshire S Corporation
    • New Jersey S Corporation
    • New Mexico S Corporation
    • New York S Corporation
    • North Carolina S Corporation
    • North Dakota S Corporation
    • Ohio S Corporation
    • Oklahoma S Corporation
    • Oregon S Corporation
    • Pennsylvania S Corporation
    • Rhode Island S Corporation
    • South Carolina S Corporation
    • South Dakota S Corporation
    • Tennessee S Corporation
    • Texas S Corporation
    • Utah S Corporation
    • Vermont S Corporation
    • Virginia S Corporation
    • Washington S Corporation
    • West Virgina S Corporation
    • Wisconsin S Corporation
    • Wyoming S Corporation
  • Contact Nelson CPA
You are here: Home / retirement / Working Longer Avoids Sequence of Returns Risk

Working Longer Avoids Sequence of Returns Risk

March 1, 2023 By Stephen Nelson CPA

Working longer avoids sequence of returns riskThe term “sequence of returns risk” refers to the risk that your retirement nest egg may not last if you get a bad patch of returns at the start of retirement.

That reality doesn’t really have anything to do with this blog’s usual subjects: tax laws, accounting, and small business.

But in a recent post about why entrepreneurs often ought to consider working longer, I commented that working longer lets someone avoid sequence of returns risk. Some people challenged that a bit. And asked some questions.

So I wanted to elaborate. But let’s start at the beginning.

An Example of Sequence of Returns Risk

Many people know that history suggests you can usually draw four percent from your nest egg and then adjust the withdrawal amount annually for inflation.

Someone who starts retirement with $1,000,000 can draw $40,000 the first year.

In the second and all subsequent years, they can bump up the previous year’s draw amount for inflation.

If inflation runs five percent in year one, in year two the person can draw $42,000. Because $42,000 is five percent more than $40,000.

Almost always, that four percent draw rate works. In fact, only five cohorts of retirees would have failed when using a four-percent draw for a thirty-year retirement since roughly when the U.S. Civil War ended. People starting in 1965, 1966, 1967, 1968 and 1969.

And those five failing cohorts? They fail because of a bad patch of returns (and inflation) as the person’s retirement starts.

Avoiding Sequence of Returns Risk

No one can know ahead of time whether they start retirement at the wrong time. Sequence of returns risk will be apparent only when you or I look in the rearview mirror.

But this maybe useful observation: Work a few years longer? Maybe three or four or five years longer… so you move the start of retirement farther into the future?

Well, do that and you inoculate your retirement portfolio against sequence of returns risk.

Fact-checking the Math

You can check my math on this. And should. Here’s how.

Visit the cFIREsim retirement planner and click Run Simulation button. cFIREsim will calculate roughly 120 retirement planning scenarios where someone with a $1,000,000 plans to retire for three decades starting immediately and where the person plans on a $40,000 draw to start.

Five scenarios, or roughly four percent, fail. All because of a bad sequence of ugly returns and terrible inflation in the late 1960s and through the 1970s.

Then, add five years to the retirement start date and click the Run Simulation button again. cFIREsim will again calculate roughly 120 scenarios for someone with a $1,000,000 who plans to draw $40,000 to start and annally adjust for inflation. But with a tweak. This time, the person calculates scenarios where retirement starts in five years, not today, and then runs for twenty-five years.

When you run this second “work longer” scenario? No historical scenarios fail (at least using cFIREsim’s default asset allocation of 75 percent stocks and 25 percent bonds.) Because the person dodges the sequence of returns risk.

Why Working Longer Works

And why does working longer work? A couple of reasons basically.

First, when retirement portfolios fail because of a bad sequence of returns at the start, failure occurs at the tail end of the retirement. Shortening the length of retirement in effect cuts off the tail where failures potentially occur. That’s the first big reason working longer works.

A second thing that helps when you work longer? The extra compounding of investment returns on a larger portfolio. That compounding nicely bumps up the size of a retirement nest egg. Working five more years, for example, on average bumps the starting retirement nest egg size by maybe 30 to 40 percent percent? And then a related point: If you or I work longer, we can probably add a bit more to the nest egg.

Note: Using the cFIREsim default portfolio settings and delaying retirement for just three years zeroes out one’s sequence of returns risk. Historically, then, you don’t actually need to work five years longer. Just three. And that’s assuming you don’t add to your retirement nest egg.

Final Comments

A couple-three final comments to wrap up this short essay.

First, most people don’t retire with a $1,000,000. Or anything near that amount. I used $1,000,000 here because it makes the math easy. And because that’s the number cFIREsim uses as its default.

Second, if you have a job you hate? This plan doesn’t work. You know that. I know that. This idea to work longer is a plan for people who like work and all it entails. Or maybe an idea for people who like work most days.

A final third point: This idea of working longer isn’t the only way dial down your sequence of returns risk. Other tricks and techniques exist. For more information, check out our series on developing a “Plan B for retirement.”

 

Filed Under: personal finance, retirement

Primary Sidebar

Welcome

Nelson CPA publishes this blog to help and encourage small business owners. Click here to learn more about our firm.

Need to help clients with their PPP loan forgiveness applications?

Updated for 2019 tax year changes and now available in print from Amazon!!

Maximizing Sec. 199A Deductions

International tax issues?

Preparing US tax returns for international taxpayers

Maximize S corporation tax savings

Setting Low S Corporation Salaries

Free retirement planning help

Picture of Thirteen Word Retirement Plan book

Featured Posts

Washington state capital gains tax returns will need to be filed for 2022 as per the Supreme Court's March decision.

Filing Washington State Capital Gains Tax Returns

You maybe need to file a Washington state capital gains tax return with your 2022 federal tax return. Specifically, if you realized long-term … [Read More...] about Filing Washington State Capital Gains Tax Returns

How IRS audits work

How IRS Audits Work

Audit anxiety is something nearly every taxpayer has in common.  But, have you ever considered how IRS audits actually work? The IRS processes … [Read More...] about How IRS Audits Work

If you got caught in an ERC scam, take these steps to reduce the damage

If You Got Conned in ERC Scam

You wondered at the time whether it was a scam, right? And now you regularly see news reports about ERC scams. Employee retention credit scams, that … [Read More...] about If You Got Conned in ERC Scam

Recent Comments

  • Stephen Nelson CPA on Lottery Tax Planning for a Billion Dollar Drawing
  • Morgan on Lottery Tax Planning for a Billion Dollar Drawing
  • Stephen Nelson CPA on Lottery Tax Planning for a Billion Dollar Drawing
  • Stephen Nelson CPA on Lottery Tax Planning for a Billion Dollar Drawing
  • Chanan Goldberg on Lottery Tax Planning for a Billion Dollar Drawing

Archives

Copyright © 2023 Stephen L. Nelson, Inc. · News Pro On Genesis Framework · WordPress