TSP Beneficiary Account and Tax Burden to Successors

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Info_Hound
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TSP Beneficiary Account and Tax Burden to Successors

Post by Info_Hound » Thu Sep 25, 2014 9:58 am

Just read this column which identified another reason people with TSP beneficiary accounts decide to move their funds out of the TSP. It looks like the TSP board will wait until November to announce what course of action they will take (if any) in changing their withdrawal options. They can't change the outcome of the situation as noted below because it's the IRS tax code vs. TSP rules. I thought our TSP invested members might find this informative.

http://www.federalnewsradio.com/?nid=180&sid=3707689
Kim Weaver, director of external affairs for the Federal Retirement Thrift Investment Board, this what she told us:
"However, there is a very important tax planning issue to keep in mind about a beneficiary participant account. When the beneficiary spouse dies, his/her beneficiaries may not transfer or roll over the money to an IRA. The money left in the account must be paid to the successor beneficiary(ies) as a single payment and may not be transferred or rolled over to an IRA. This could create a tax burden on the beneficiaries of the spousal account. (This is not a TSP rule, but an outcome required by the Internal Revenue Code.)

"If the beneficiary spouse, however, rolls the money out of the TSP into an IRA at some point, then when the inheriting spouse dies, his/her beneficiaries can roll the money into an IRA (including inherited IRAs which allow delays of the tax on the money).

"So, this tax issue is not a reason for a participant to roll his or her money out of the TSP, but it is something that a spousal beneficiary should think about carefully. I hope this is clear — there are a lot of moving parts in this one."

Alan S.
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by Alan S. » Thu Sep 25, 2014 6:50 pm

I don't have first hand knowledge of the TSP, but some research confirms the main point of the article.

TSP beneficiary options are very limited in comparison with almost all other plans. By TSP definition, a "beneficiary participant account" is limited to a surviving spouse. A non spouse beneficiary of the participant or of the surviving spouse with a beneficiary participant account will not be able to stretch their RMDs, they will have to receive a taxable lump sum payment.

To constrast, a non spouse beneficiary of other employer plans has considerable flexibility including direct rollover to an inherited TIRA or an inherited Roth IRA or in many cases continuing to receive RMDs from the plan. And with the new IRS Notice 2014-54, a non spouse beneficiary can even specify that any basis in the pre tax portion of the plan can be transferred to an inherited Roth while the pre tax portion could go to an inherited TIRA.

The lump sum payout from the TSP to a non spouse beneficiary can result in much higher marginal rates for the distribution year, so not only is the stretch forfeited, but a very high marginal rate on the lump sum is possible.

Therefore, a participant at retirement or even before retirement if health is declining and they have a non spouse beneficiary, they should attempt to roll their balance to an IRA while they have the chance. The beneficiary will not have this option.

gkaplan
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by gkaplan » Thu Sep 25, 2014 7:42 pm

What is the difference between a TSP Beneficiary account and a regular TSP account?
Gordon

kazper
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by kazper » Thu Sep 25, 2014 9:20 pm

Crap, that sucks. Does it also apply to those of us not retirement age? If I die, does my wife have to take all the money out of my tsp and suffer the tax consequences? Sure hope not!!

Alan S.
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by Alan S. » Thu Sep 25, 2014 9:46 pm

kazper wrote:Crap, that sucks. Does it also apply to those of us not retirement age? If I die, does my wife have to take all the money out of my tsp and suffer the tax consequences? Sure hope not!!
No, a spousal beneficiary is the only type of beneficiary eligible for the beneficiary participant account, therefore there is no problem until the spouse passes and a child for example receives the account. Then it must be distributed.

trueblueky
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by trueblueky » Thu Sep 25, 2014 9:48 pm

gkaplan wrote:What is the difference between a TSP Beneficiary account and a regular TSP account?
A regular TSP account is what a federal employee, servicemember or retired holds. A TSP beneficiary account is what the spouse gets when that person dies. So, the spouse should consider transferring from TSP to an IRA at that point.

Enkidu
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by Enkidu » Fri Sep 26, 2014 9:49 am

I like the TSP for the low fees and the G fund for bonds, but the tax implications for potential beneficiaries should not be overlooked, and at some point outweigh the benefits in my opinion. Also, I expect our marginal tax rate on withdrawals to be higher after age 70 because we are delaying SS.

I have written instructions for my wife to roll TSP to her Vanguard IRA if I die. If my wife dies before me I would roll TSP to an IRA over a time- assuming that I remain in good health. I will also roll as much as possible to a Roth IRA while delaying SS until 70.

kazper
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by kazper » Fri Sep 26, 2014 10:10 am

Alan S. wrote:
kazper wrote:Crap, that sucks. Does it also apply to those of us not retirement age? If I die, does my wife have to take all the money out of my tsp and suffer the tax consequences? Sure hope not!!
No, a spousal beneficiary is the only type of beneficiary eligible for the beneficiary participant account, therefore there is no problem until the spouse passes and a child for example receives the account. Then it must be distributed.
Thanks for the clarification Alan S.!

It's definitely something to consider if I bequeath anything to my little one. Then again, he'll probably be what drives me into the grave :shock:

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hoppy08520
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by hoppy08520 » Sat Oct 04, 2014 10:00 am

Interesting thread, thank you. I'm curious about one aspect of this, specifically the worst part about this rule which is that beneficiaries of beneficiary participants must take a taxable distribution and cannot put their death benefit into an inherited IRA. My question is this: Do 401(k)/403(b) ERISA plans have the same rule?

The TSP rep said in that original quote:
(This is not a TSP rule, but an outcome required by the Internal Revenue Code.)
I'm not sure what the TSP rep means by this.

I do understand that the TSP has limited options for the beneficiary participants of the original TSP account holder, in that only a spouse can be a beneficiary participant, and that non-spouse beneficiaries must take a distribution or an inherited IRA of their death benefit. I get that this is a TSP rule and not an ERISA/IRS rule.

But what about the distribution options for beneficiaries of the beneficiary participant? When the TSP rep says "this is not a TSP rule", does she mean that 401(k)/403(b) plans also require the beneficiaries of beneficiary account holders to take a taxable distribution upon the death of a beneficiary participant and are not able to put their benefit into an inherited IRA?

Example Scenario 1 with TSP: Mike and Carol are married and have a daughter named Marsha. Carol has a TSP account. Carol dies and Mike assumes her TSP as a beneficiary account. Mike dies and Marsha gets the benefit, but must take it as a taxable distribution.

Example Scenario 2 with 401(k): Mike and Carol are married and have a daughter named Marsha. Mike has a 401(k) account. Mike dies and Carol assumes his 401(k) as a beneficiary. Carol dies and Marsha gets the benefit. QUESTION: Can Marsha assume the 401(k) as her own (do plan rules govern this, or IRS rules)? If not, can she distribute the 401(k) into an inherited IRA, or must she take it as a taxable distribution (as in Scenario 1 with TSP)?

Alan S.
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by Alan S. » Sat Oct 04, 2014 6:48 pm

With respect to eligible retirement plans (401k, 403b, 457), under Sec 829 of the PPA (2006), these plans were allowed to offer a non spouse designated beneficiary a direct rollover to an inherited IRA. Under WRERA (12/2008), starting in the next plan year after Jan, 2009 these direct rollovers became mandatory for those beneficiaries requesting them.

Note that a successor beneficiary is NOT a designated beneficiary, so a direct rollover for successor beneficiaries is not allowed under the tax code (Sec 402(c)(11). A designated beneficiary includes individual beneficiaries of a qualified trust. In any event a successor beneficiary does not have access to a direct rollover in either the TSP or these other plans, so the TSP rep was correct about that IRS requirement.

However, not having access to a direct rollover to an inherited IRA does not mean that a 401k account could not allow the successor beneficiary to complete their RMD requirements using the same schedule that the original designated beneficiary was using. That is still a stretch of sorts with much better tax implications than a lump sum distribution as required by the TSP for either the non spouse beneficiary OR the successor beneficiary of a spouse under a beneficiary participation account. I cannot tell you how likely a 401k is to offer this. It could be that none of them offer it.

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hoppy08520
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Re: TSP Beneficiary Account and Tax Burden to Successors

Post by hoppy08520 » Sat Oct 04, 2014 7:49 pm

Alan, great information, as always! Thank you. I tried searching for this and came up short, it's so obscure and the search terms are so generic that you can't find what you're looking for.

FYI, there's now a wiki page on this topic: TSP Estate Planning.

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