Case Study: What Could Go Wrong for a $6 Million Couple With Two State Pensions

The setup: partner A retires at 55 in two months, partner B follows at 57 in two years. Combined state pensions pay $120,000 a year with a cost-of-living adjustment capped around 2 to 3 percent. Mandatory expenses run $50,000 a year, with roughly $70,000 more for discretionary spending. A $3 million taxable brokerage account is earmarked for long-term care self-insurance and one-off purchases. A separate $3 million in pre-tax accounts is treated as a backup to the pension. The couple's only named risk was a state pension system funding collapse, which is possible in theory but is the least likely large risk on this list.

Most state pension systems require an irrevocable choice at retirement between a higher single-life payout and a reduced payout that continues, at some percentage, to a surviving spouse. With $6 million in other assets, this couple has an option most retirees do not. If the surviving spouse would be financially fine without a continued pension payment, because the brokerage and pre-tax accounts can cover the gap, taking the higher single-life payout and self-insuring the survivor risk with existing assets may be the more efficient choice. If the numbers do not support that, the joint-survivor election protects the smaller estate. Either answer can be correct. Defaulting into whichever option the paperwork lists first, without running this comparison, is the actual mistake.

A bigger risk than a pension collapse is a plain bear market hitting the $6 million in invested assets with no agreed plan for it. Two questions need specific answers, not a gut feeling. First, given the couple's actual asset allocation, how much could this portfolio reasonably lose in a serious downturn, on the order of 2008 or worse. Most people underestimate this until they have lived through it once. Second, what is the actual plan once that happens. Is spending reduced, and by how much. Is the taxable account the funding source while the pre-tax account is left alone to recover. Is there a specific, written trigger for cutting discretionary spending, rather than a vague intention to pare down. Deciding this in the middle of a 30 percent drawdown, under stress, is how people either sell at the bottom or wait too long to adjust. Deciding it now, on paper, while markets are calm, is how the plan actually gets followed.

Nobody in the original scenario mentioned what these accounts are invested in or what they cost to hold. On $6 million, the gap between a low-cost, efficient portfolio and one layered with fund expense ratios, advisory fees, or embedded product costs is not a rounding error. A 1 percentage point difference in annual cost on $6 million is $60,000 a year, every year, for as long as the money stays invested. Over a 30-year retirement that is not a one-time cost, it is a permanent tax on the entire plan. Before anything else gets optimized, it is worth knowing exactly what is being paid, in total, across every account, and what that cost is actually buying.

Turnover inside the taxable brokerage account compounds the problem. High turnover in the funds or strategies held there means more buying and selling inside the fund, which means more realized short-term and long-term gains passed through to the couple every year, whether or not they touch the account. Add ordinary interest income and capital gains distributions from actively managed or poorly structured funds, and $3 million in a taxable account can generate a meaningful, avoidable tax bill every single year, on top of $120,000 of pension income that is already taxable. A low-turnover, tax-managed approach, with asset location coordinated between the taxable and pre-tax accounts, addresses most of this drag directly.

The plan, as described, is to let the $3 million pre-tax account grow while the pension and taxable account cover most spending, taking a voluntary withdrawal of roughly 3 percent a year. Required minimum distributions do not care about that plan. Using the older spouse's current age as the reference point, and assuming the account grows 5 percent a year, the table below compares the couple's planned 3 percent withdrawal against what the IRS actually requires once RMDs apply, using the current Uniform Lifetime Table.

The required percentage climbs every year as the account owner ages, from roughly 4.1 percent at 75 to 6.25 percent at 85, while the couple's voluntary rate stays flat at 3 percent. By 85, the IRS is forcing out more than double what they had planned to withdraw. This stacks directly on top of pension income that is also growing with its own cost-of-living adjustment. A pension that has grown to roughly $240,000 a year by then, combined with an RMD north of $325,000, could put this household above $550,000 of taxable ordinary income annually in their mid-80s, likely their highest bracket of the entire retirement, arriving right as spending needs typically decline rather than rise. That is also the range where Medicare IRMAA surcharges stack on top of the income tax itself.

Then there is what happens after the first spouse dies. The surviving spouse files as a single taxpayer, in narrower brackets, often with the same or nearly the same income. That is the surviving spouse tax problem, and it lands directly on top of this already elevated RMD picture, not instead of it.

It does not stop with the surviving spouse either. Non-spouse beneficiaries who inherit this account must empty it within 10 years under current law. If it has grown into a multi-million dollar balance by then, the beneficiaries could be forced into large taxable distributions during their own peak earning years. The parents' unmanaged deferral becomes the children's tax problem.

One practical gap belongs in this same conversation even though it never touches the investment accounts. Both spouses are retiring well before Medicare eligibility at 65, one by ten years and one by eight. That gap has to be filled with COBRA or ACA marketplace coverage, and at this income and asset level, ACA subsidy eligibility is not guaranteed. Full premiums for a healthy pre-65 couple can run into five figures annually, a cost that belongs in the mandatory expense line and often is not budgeted for at all.

• Treating a pension funding collapse as the primary risk in the plan, when a plain market drawdown in the $6 million portfolio is both more likely and easier to prepare for in advance.
• Accepting the pension's default survivor election without modeling whether the couple's other $6 million in assets makes the higher single-life payout the more efficient choice.
• Having no specific, written plan for how much a bear market could reasonably take from the portfolio, and what spending changes it would trigger, before markets actually drop.
• Not knowing the total fees and expense ratios being paid across every account. A 1 percentage point cost difference on $6 million is $60,000 a year, every year.
• Holding high-turnover funds or strategies inside the taxable brokerage account, generating realized gains and ordinary income every year regardless of whether the couple touches the money.
• Assuming a flat, voluntary withdrawal rate from the pre-tax account will satisfy future RMDs. The required percentage rises every year with age and can end up forcing out more than double a household's planned withdrawal by their mid-80s.
• Retiring years before Medicare eligibility without budgeting for the actual cost of COBRA or ACA marketplace coverage, which is not guaranteed to be subsidized at this income and asset level.