There is a lot of confusion regarding inherited IRAs, especially as they pertain to spousal inherited IRAs and TSP. What happens when a federal employee or retiree dies and has a Thrift Savings Plan account?
Luckily, there are a lot of different options for a surviving spouse. But, figuring out the best option isn’t always easy.
TSP Beneficiary Participant Account
The first and easiest option is to move the TSP to a Beneficiary Participant Account (BPA) in the surviving spouse’s name. This allows the living spouse to maintain the TSP just as the deceased spouse did.
However, there is one big issue with a BPA:
All funds must be withdrawn at the time of the owner’s death.
This can be costly! Doing it this way can cost beneficiaries tens of thousands of dollars (if not more). This alone makes it worthwhile for a surviving spouse to consider transferring TSP to an IRA.
But why would an IRA be better? Because an IRA (1) can be a lot more flexible and (2) give beneficiaries more options upon the owner’s death.
Transfer TSP to Your Own IRA
Transferring TSP to your own IRA is probably the easiest of your options and accomplishes a couple things:
- Provides better options for beneficiaries when they inherit the IRA
- Simplifies your financial life—having one account versus two
Spouses are the only beneficiaries that are allowed to transfer an inherited IRA or retirement plan into their own IRA.
When should you choose this option?
Beneficiaries that are age 59 ½ or older would likely want to choose this option.
This option is preferable if the account will pass on to your kids because it gives your kids a 10-year time window to take distributions (possibly longer if they are an eligible designated beneficiary). Why is this important? Because it allows the beneficiary to spread the tax burden out over a longer time period versus having to distribute the account immediately upon the owner’s death. This can same you beneficiaries thousands of dollars.
Transfer to an Inherited IRA
Transferring to an inherited IRA is most beneficial when the surviving spouse is under 59 ½. An inherited IRA gives you access to the funds immediately. There are different rules depending on when the deceased spouse dies, but all of them give the surviving spouse 100% access to the funds.
A disadvantage to an inherited IRA is that a beneficiary may be forced to take distributions. A surviving spouse falls under the category of an eligible designated beneficiary (EDB); an EDB must take distributions if the deceased died after his/her required beginning date (RBD), or once the deceased would have turned age 72.
Even if you choose to do a transfer to an inherited IRA, you can always transfer the funds into your own IRA. This is only true for spouses.
Billy inherits a TSP account from his wife Jean. Jean was age 60 when she died and Billy is 53. Billy chooses to move Jean’s TSP to an inherited IRA. This gives Billy access to funds in the inherited IRA and he isn’t forced to take distributions until the year that Jean would turn age 72. In this scenario, Billy would likely want to transfer the inherited IRA to his own IRA prior to the year that Jean would turn age 72.
The inherited IRA also gives Billy’s beneficiary more time to withdraw funds from their own inherited IRA. The beneficiary could potentially be an EDB, or at worst, have a 10-year time period to withdraw the funds.
Using an Inherited IRA to Delay Required Minimum Distributions (RMDs)
An inherited IRA can also be beneficial if the surviving spouse is older than the deceased spouse. In this scenario, you could use the inherited IRA to delay RMDs. Here is an example:
Mary dies at age 60 and her husband John is age 72. John may choose to move funds to an inherited IRA because he could delay RMDs until the year Mary would turn age 72.
An inherited IRA also allows Qualified Charitable Distributions as long as the account holder is age 72 or older. This can be a huge help come tax time if the RMDs aren’t needed for immediate income.
Making the Best Decision for Yourself and Your Family
Spouses have a number of choices on how to handle an inherited TSP or IRA. Please take the time to understand the pros and cons of each and proceed accordingly.