TSP Beneficiaries of Beneficiaries

[clydewolf]

The government’s TSP operates much like a 401k, but it is not a 401k plan. The TSP was created under a separate federal law. As a result, some states that exempt income tax from 401k contributions are taxing contributions to the TSP.

There are some other differences for surviving beneficiaries too. The surviving spouse can continue with the TSP account still in the TSP as a beneficiary account. Or they can transfer the TSP to a Beneficiary IRA or as their own IRA. With the TSP the surviving spouse can name new beneficiaries, and contingent beneficiaries. They can do the same with the Beneficiary IRA.

Keeping the TSP account, if the surviving spouse were to die, the beneficiaries named to the beneficial account, have some unfortunate surprises. These beneficiaries will receive the TSP account balance, but it must be a lump sum distribution. The named beneficiaries would be required to pay taxes on the entire amount. There is no option to transfer this to an IRA and take RMDs as a beneficiary over their life time.

Example: G. I. Joe is a TSP Participant and has his spouse Barbie, named as sole beneficiary. They have 2 children, Richard and Jane. G. I. Joe dies. Barbie promptly keeps the TSP account as a beneficiary account, and names their children Richard and Jane as equal beneficiaries. Barbie continues her life as best she can taking distributions from the TSP. Barbie dies a few months later. Richard and Jane are stuck with taking a lump sum distribution from the TSP, and paying the necessary income taxes on that distribution. They do not have an option to move this money to their own IRA, or to their employer’s 401K.

In the TSP pamphlet titled Death Benefits for Participants and Beneficiaries dated December 2010, on page 4-b we find:
“Beneficiary of a Beneficiary - A beneficiary of a beneficiary participant account (i.e., an account inherited by the spouse of a deceased TSP plan participant) cannot transfer or rollover a death benefit payment into any type of IRA or plan.” https://www.tsp.gov/PDF/formspubs/tspbk31.pdf

If you are are a TSP participant, you need to make your beneficiaries aware of the taxation of receiving a beneficiary distribution from your account.