Should clients in the 'retirement red zone' reconsider withdrawal strategies?

It’s a tough time to be a retiree. Despite a slight recovery after President Trump paused his tariff policies, the angst over how those levies will affect the economy has fueled a selloff in U.S. equities that has sent the S&P 500 tumbling some 14% from its February high, spurring investor fears about future declines.

Financial advisors describe the current decline as an opportunity for many investors who have decades of time left in the market. But for retirees who are hoping to generate income from their investments, a short-term decline in their portfolios could spell long-term trouble for their retirement plans.

“For those approaching or entering retirement — the ‘retirement red zone,’ as I call it — the five years before and after retirement are absolutely critical,” said Carlos Salmon, a financial advisor at Wooster Square Advisors in New Haven, Connecticut. “With the S&P 500 down … from its high this year, it’s understandable that retirees and near-retirees are concerned about withdrawing assets in a declining market.”

A sharp drop in invested assets early in retirement can have a snowball effect on a retiree’s financial position later in life, advisors say. This phenomenon, otherwise known as a sequence-of-returns risk, has the potential to derail a person’s retirement plan, shortening the expected lifespan of their savings by years.

Simulations from the Schwab Center for Financial Research help illustrate the impact of investment declines in early retirement. In the simulation, two investors enter retirement with $1 million in investments. Both retirees start off by withdrawing $50,000 — 5% of their starting balances — from their investments, which they increase by 2% each year to account for inflation.

Here’s where they start to diverge.

Investor No. 1 has average portfolio returns of minus 15% for the first three years of their retirement. After those first three years, investor No. 1’s portfolio earns 10% returns for the next 17 years. Investor No. 2 has the mirror experience, with their portfolio earning 10% returns in the first 17 years before experiencing 15% declines for the last three years.

On average, the two retirees see the same average return over a 20-year span, but their outcomes are drastically different. Investor No. 2 ends up with over $1.3 million in assets — more than they started with — while investor No. 1 runs out of money in just over 17 years.

“Investors who are just about to retire or have already retired should have a proactive withdrawal strategy already in place to protect themselves from this ‘sequence-of-returns’ risk,” said Paul Winter, founder of Five Seasons Financial Planning in Salt Lake City. “Whether that protection strategy should be having a ‘cash bucket’ in place within their portfolios, or a reverse mortgage line of credit or HELOC in place, or true diversification within their portfolios, or a bond ladder or a combination of these, is up to a given investor.”

No matter the particular strategy, advisors say the important thing is to have a retirement plan that can navigate short-term declines without damaging long-term investments. For some advisors, achieving that is as simple as keeping more cash on hand.

“If you are close to retirement or in retirement, you should have between 18 to 24 months in cash to weather the ups and downs of the market and insulate yourself from market corrections,” said Michael Hansen, co-founder of Frontier Wealth Strategies in Walnut Creek, California.

Preparing effectively for such downturns starts years in advance, advisors say. “If [a client] had made contact five to 10 years prior to retirement, they would have a balanced portfolio that simply isn’t experiencing the volatility the total stock market is seeing today,” said John Power, a financial advisor at Power Plans in Walpole, Massachusetts.

Data shows that many retirees fall short of that mark. In 2024, 41% of retirees said they did not have three months of emergency savings, up from 31% in 2022, according to a survey from Employee Benefit Research Institute.

For Americans in the retirement red zone who lack robust cash reserves, advisors say there are still a couple of strategies, like lowering withdrawals and delaying retirement, that can help preserve long-term retirement goals.

“You’ve heard the 4% rule but, you know, that’s a function of where you are in the market cycle,” said Keith Fenstad, vice president and director of wealth planning at Tanglewood Total Wealth Management in Houston, Texas.

For early retirees who are heavily reliant on their investment portfolios for income, it’s critical to reduce distributions during a down market, Fenstad said.

“What happens on the front end of your retirement changes exponentially the long term,” he said. “So if [a client] really needs to [retire], then I’m saying, ‘Let’s focus on being the most conservative with our spending now, with the opportunity of trending up, just given the current uncertainty.”

Retirees can also reduce their immediate reliance on investments by delaying retirement, Fenstad said.

“There’s no greater thing a person can do to secure their retirement than to just work another year,” he said. “That’s one more year of theoretical growth and appreciation, one less year of distributions. That’s the single biggest thing to shore up [retirement].”

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Should clients in the 'retirement red zone' reconsider withdrawal strategies?

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