A surviving spouse is the only survivor that can leave inherited funds in the Thrift Savings Plan (TSP). It is very common for a federal employee to tell their spouse to leave the funds in TSP should the spouse survive the federal employee spouse.
Let me share an example of how a hypothetical conversation between a couple may go.
Meet Christopher & Angelica
hen we both have passed
Christopher was taught by his wise grandfather as a young lad, that to be financially dependent, he needed to start saving and investing early on.
As soon as he graduated from college and secured employment with the government, he diligently contributed the maximum allowed into his TSP account each year. Christopher allocated his TSP funds within his comfort level and did not panic when the stock market took a downturn.
At retirement, Christopher had accumulated $1.2 million in this TSP account. During retirement, he withdrew less than 4% to supplement their income need.
Christopher’s TSP continued to grow and had reached $1.4 million when he passed at age 86.
Angelica did as Christopher had instructed and kept the funds in the TSP. The account had to be turned into a Beneficiary Participation Account (BPA), and Angelica made sure to designate their two children (Harry and Danielle) as beneficiaries.
Some basic rules for a BPA Account
- Only available to a spouse
- Surviving spouse can leave funds in TSP
- BPA account owner can access funds the same way TSP owner did (partial withdrawal, monthly payments, annuity and full withdrawal)
- Surviving spouse designates beneficiaries on Form TSP-3
- At surviving spouse’s death, funds cannot remain in TSP
In addition, the surviving spouse must take Required Minimum Distributions (RMDs), based on the deceased TSP participant’s age, starting by April 1st of the year following when the deceased participant would have turned age 70 ½. (If the RMD is taken by April 1st the year after the deceased participant turned age 70 ½, an RMD would also have to be taken by the end of the same year).
Each and every year after the deceased participant would have attained 70 ½, an RMD must be taken. These distributions are based on the BPA owner’s life expectancy. Find important tax information about TSP withdrawals and RMDs for beneficiary participants.
Required Minimum Distribution Rules for Beneficiary Participant Accounts
|Date of death is:||Payment required in year of death||Payment required in years following year of death*|
|Before required beginning date||No RMD payment required for beneficiary participant||Must begin receiving annual RMDs by either 12/31 of the year the deceased participant would have turned 701⁄2 or 12/31 of the year following the year of death, whichever is later. Must continue to receive RMDs by 12/31 of each year thereafter.|
|On required beginning date (4/1)||Payment required by 12/31 of the year of death, unless already paid**||Must receive an annual RMD by 12/31 of each year following the year of the participant’s death.|
|After required beginning date||Payment required by 12/31 of the year of death, unless already paid**||Must receive an annual RMD by 12/31 of each year following the year of the participant’s death.|
|* Payments will be calculated using the previous year-end account balance and the beneficiary participant’s age.
** Whether or not the deceased participant had begun receiving RMDs is irrelevant. The determining factor is whether the participant died before his or her required beginning date (April 1) or on/after his or her required beginning date. Payment will be based on the prior year-end account balance and the deceased participant’s age.
The IRS single life table is what the BPA owner must use to calculate the RMDs, which require a higher withdrawal than IRS Uniform Table, which can be used by the TSP participant, not the BPA holder. Refer to TSP-776 Publication.
Unlike beneficiaries of a TSP participant account, beneficiaries of a TSP BPA are not eligible to rollover their inheritance into an Inherited IRA.
After Angelica’s Death
So, what will happen when Angelica passes away? Assuming Angelica continues to take the required minimum distribution based on her life expectancy and not allocate all of her TSP into the C, S and I funds and then panic sell when there’s a downturn locking in her losses, she is likely to pass on a sizeable inheritance to their children, Harry and Danielle.
Let’s assume when she passes her TSP BPA is still at $1.4 million.
Now, Harry and Danielle were raised by very responsible parents, and Christopher had passed on his conventional wisdom to them.
Harry and Danielle have done well for themselves. Both educated and very successful in their careers, they have employment income that more than meets their needs and would most likely want to rollover an inheritance in the most tax efficient way. (Yes, we all have children just like this).
Well, what would their father, Christopher, do if he knew that this was not allowable due to the stringent TSP BPA rules that disallow a beneficiary of a BPA account to rollover to an Inherited IRA?
The consequences would mean that they would each inherit $700,000 thousand dollars, only to share about half of that with good old Uncle Sam. Christopher really hated paying taxes and he would be rolling over in his grave if he knew that all of his careful planning had gone to waste because he didn’t understand the TSP BPA account rules!
Beneficiaries of a TSP BPA
- Paid out directly as the BPA account owner designates
- Proceeds cannot be rolled into an Inherited IRA Causes entire amount to be taxable as ordinary income at each beneficiary’s tax rate
A spousal beneficiary also is eligible to rollover TSP into his/her own IRA and be able to take minimum distributions based on the more favorable Uniform table, and do this when they turn age 70 ½. They can also name beneficiaries of their IRA and beneficiaries can do a stretch IRA, rolling over the IRA to an Inherited IRA, and take distributions based on their life expectancy.
But there is still a chance for Angelica because although she has turned Christopher’s TSP into a BPA, she can still roll over this account to her own IRA. This would allow her children to rollover to an Inherited IRA and avoid a lump sum tax payment once Angelica passes.
Addressing the risk of losing a spouse is a very important topic that needs to be addressed as part of your overall financial and retirement planning process, not only regarding the TSP, but also addressing losing half of a pension, one Social Security payment, and potentially paying a higher tax as a single filer.