Beneficiary Beware

The tax consequences of inherited TSP accounts can be tricky.

You might want to keep this column attached to your TSP-3 beneficiary designation form.

My associate Joe Sullender, senior vice president for investments at Wells Fargo Advisors, recently became aware of a potential tax consequence of leaving your Thrift Savings Plan balance to your spouse in a beneficiary participant account. After reading what comes next, you might decide you need to consult a CPA, an estate planning attorney and a financial adviser if you inherit an IRA, 401(k) or TSP account.

If you are married, it is most likely you would want your spouse to inherit the balance of your TSP account. This would happen automatically through the standard order of precedence if there is no designated beneficiary on file, in which case the spouse is first in line to inherit the benefit. If your spouse's share is $200 or more, the TSP would maintain the beneficiary participant account and invest the entire share in the Government Securities Investment (G) Fund until your spouse makes a different investment choice or withdraws the money as a single payment, monthly payments, annuity or a combination of these options.

In the case of a non-spousal TSP participant account -- which is different from a TSP beneficiary participant account --  the beneficiary could establish an inherited IRA, in which the funds could be stretched over the life expectancy of the beneficiary and taxes would be due as payments are made.  In a recent personal finance column in Forbes, Deborah Jacobs notes there are some important things you need to know when inheriting an IRA. Jacobs outlines five rules for maximizing tax benefits for beneficiaries. A non-spousal beneficiary of a TSP participant account could take advantage of an inherited IRA, for example, to avoid the immediate taxation of the inherited account balance.

Be aware that these rules for establishing an inherited IRA do not apply when inheriting a spousal beneficiary participant account from the TSP.

Here is the language that will explain this further from the TSP Beneficiary Participant Booklet:

Death benefit payments made from your beneficiary participant account must be paid directly to your beneficiary(ies). These payments are subject to certain tax restrictions and cannot be transferred or rolled over into an IRA or eligible employer plan. In addition, your beneficiary(ies) will have to pay the full amount of taxes on the taxable portions of the payment in the year it is received. (Your beneficiaries will not owe taxes on Roth contributions, qualified earnings on Roth contributions, and tax-exempt contributions in the account.) For detailed information about the rules associated with death benefit payments, read the TSP tax notice “Important Information about Thrift Savings Plan Death Benefit Payments.” You may also want to consult a tax advisor.

In order for your beneficiaries to receive your account balance after your death, they (or their representatives) must complete Form TSP-17, Information Relating to Deceased Participant, and send it to the TSP along with a copy of the certified death certificate. Once the TSP processes this information and determines the beneficiaries for your account, we will contact them with additional information and instructions.

In a recent example, one of Sullender’s clients inherited her husband’s TSP balance in a beneficiary participant account. She decided to leave the money in the account, and upon her death the balance had grown to $700,000. Her account was then payable to her adult children in equal shares. Sullender advised the heirs to establish beneficiary IRA accounts so they could continue to defer taxes on the money and stretch the payments and taxes due over their life expectancy.

The problem arose when they attempted to transfer the balance to the beneficiary IRA. Under TSP regulations, transfers from a beneficiary participant account to an inherited IRA are not tax-deferred.  This means the surviving children owe about $200,000 in taxes on their inheritance.

If the widow had rolled her husband’s TSP into an IRA upon his death, her children wouldn’t have to pay immediate taxes on $700,000. They would have been able to set up an inherited IRA and stretch the tax burden over their own life expectancy. A costly lesson learned.

X
This website uses cookies to enhance user experience and to analyze performance and traffic on our website. We also share information about your use of our site with our social media, advertising and analytics partners. Learn More / Do Not Sell My Personal Information
Accept Cookies
X
Cookie Preferences Cookie List

Do Not Sell My Personal Information

When you visit our website, we store cookies on your browser to collect information. The information collected might relate to you, your preferences or your device, and is mostly used to make the site work as you expect it to and to provide a more personalized web experience. However, you can choose not to allow certain types of cookies, which may impact your experience of the site and the services we are able to offer. Click on the different category headings to find out more and change our default settings according to your preference. You cannot opt-out of our First Party Strictly Necessary Cookies as they are deployed in order to ensure the proper functioning of our website (such as prompting the cookie banner and remembering your settings, to log into your account, to redirect you when you log out, etc.). For more information about the First and Third Party Cookies used please follow this link.

Allow All Cookies

Manage Consent Preferences

Strictly Necessary Cookies - Always Active

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Sale of Personal Data, Targeting & Social Media Cookies

Under the California Consumer Privacy Act, you have the right to opt-out of the sale of your personal information to third parties. These cookies collect information for analytics and to personalize your experience with targeted ads. You may exercise your right to opt out of the sale of personal information by using this toggle switch. If you opt out we will not be able to offer you personalised ads and will not hand over your personal information to any third parties. Additionally, you may contact our legal department for further clarification about your rights as a California consumer by using this Exercise My Rights link

If you have enabled privacy controls on your browser (such as a plugin), we have to take that as a valid request to opt-out. Therefore we would not be able to track your activity through the web. This may affect our ability to personalize ads according to your preferences.

Targeting cookies may be set through our site by our advertising partners. They may be used by those companies to build a profile of your interests and show you relevant adverts on other sites. They do not store directly personal information, but are based on uniquely identifying your browser and internet device. If you do not allow these cookies, you will experience less targeted advertising.

Social media cookies are set by a range of social media services that we have added to the site to enable you to share our content with your friends and networks. They are capable of tracking your browser across other sites and building up a profile of your interests. This may impact the content and messages you see on other websites you visit. If you do not allow these cookies you may not be able to use or see these sharing tools.

If you want to opt out of all of our lead reports and lists, please submit a privacy request at our Do Not Sell page.

Save Settings
Cookie Preferences Cookie List

Cookie List

A cookie is a small piece of data (text file) that a website – when visited by a user – asks your browser to store on your device in order to remember information about you, such as your language preference or login information. Those cookies are set by us and called first-party cookies. We also use third-party cookies – which are cookies from a domain different than the domain of the website you are visiting – for our advertising and marketing efforts. More specifically, we use cookies and other tracking technologies for the following purposes:

Strictly Necessary Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Functional Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Performance Cookies

We do not allow you to opt-out of our certain cookies, as they are necessary to ensure the proper functioning of our website (such as prompting our cookie banner and remembering your privacy choices) and/or to monitor site performance. These cookies are not used in a way that constitutes a “sale” of your data under the CCPA. You can set your browser to block or alert you about these cookies, but some parts of the site will not work as intended if you do so. You can usually find these settings in the Options or Preferences menu of your browser. Visit www.allaboutcookies.org to learn more.

Sale of Personal Data

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.

Social Media Cookies

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.

Targeting Cookies

We also use cookies to personalize your experience on our websites, including by determining the most relevant content and advertisements to show you, and to monitor site traffic and performance, so that we may improve our websites and your experience. You may opt out of our use of such cookies (and the associated “sale” of your Personal Information) by using this toggle switch. You will still see some advertising, regardless of your selection. Because we do not track you across different devices, browsers and GEMG properties, your selection will take effect only on this browser, this device and this website.