Federal retirement expert, Chris Kowalik, helps federal employees to understand how beneficiaries work, and what happens if no one is assigned to receive the benefit upon the death of an employee or retiree.
On the surface, this may seem like just another kind of administrative topic, but there’s actually a lot more to it — such as what benefits are available that warrant a beneficiary, and what your family can expect to have paid out if something should happen to you.
There are four main kinds of federal employee benefits available to be paid out upon the death of a federal employee or retiree:
- Lump sum payments from CSRS or FERS
- Unpaid compensation (including any unpaid annual leave, travel vouchers or earned comp time)
- Thrift Savings Plan
- Federal Employee’s Group Life Insurance
You probably filed your beneficiary designations many years ago, when you were first hired—and for some, that’s 25 to 30 years ago or more. If you can’t remember who you named, it’s been too long.
The good news is that naming a beneficiary or even several beneficiaries is easy. For CSRS employees, for those lump sums available, you’ll complete the SF-2808. The FERS version of that same form is the SF-3102. For the unpaid compensation, you have the SF-1152. For TSP, you have the TSP Form 3 and then for FEGLI, you have the SF-2823. You can go to our website at www.fedimpact.com/beneficiaries and find all the forms you need right away.
If you don’t remember who is named as your current beneficiary, there are ways to check; however, these forms are so easy to fill out and will overwrite anything that you already have on file. So instead of waiting 60 days to hear back from HR, it makes sense to just file your new beneficiary and then you know who you want named is actually named.
Again, these forms are super easy, and it’ll probably take you about ten minutes to fill out all four forms, as long as you know who you want to name. These forms can be completed at any time, so there’s no open season. In other words, there’s not a particular time of year that you must submit these – they can be done at any time.
Who Should I Name?
You can name anybody that you want as your beneficiary. It doesn’t even have to be a living person—it can be an entity like a company, a church, a charity, a cause, a trust, etc. You also can name primary beneficiaries as well as contingents. For example, you could name your spouse as the primary beneficiary, but then have your children as contingent beneficiaries.
What can complicate matters is when a former spouse is named as a beneficiary. If your former spouse is still listed as the beneficiary (no matter how long you’ve been divorced or even if you’ve remarried), your former spouse is going to be paid your money when you die. Court cases have gone all the way to the U.S. Supreme Court and have been upheld, so it’s very important to have that beneficiary designation updated.
Another example is that a former spouse could presumably have rights to your money by court order and so they’re first in line. So, let’s say in a divorce decree, your former spouse was supposed to get 1,000 shares of your TSP account upon your death. If, by the time you retire, you have 2,500 shares, then your current spouse (or whoever you name as the beneficiary) would receive the additional 1,500 on top of what the court order has granted to a former spouse. It’s usually not broken out quite that simply in divorce decrees, but that is the idea.
If you’re divorced, the good news is you can name minor children to receive money from all of these different types of beneficiaries (instead of naming your former spouse). The bad news is how minors are treated upon the payout of that money is different between different beneficiary designations.
For example, your Federal Employees Group Life Insurance (FEGLI) policy will not pay out a death benefit directly to a minor child. They’re going to award it to a custodian or a guardian that is designated by the court. That very well may be your former spouse. If they have a legal parent guardian that’s still living, chances are that parent is going to get the money to be able to serve the children in the future. On the other hand, TSP will pay the money out directly to a minor.
I would encourage anybody who has minor children who they wish to be able to leave this type of money to, to consult an estate-planning attorney to ensure that you get things set up correctly. That may mean setting up a trust that allows for minor children to be cared for without the money being turned over, perhaps, to a former spouse or someone else who may step in as the guardian against your wishes. In a trust, you get to dictate who controls that money for the benefit of your children upon your death.
Special Needs Children
Another group of people who tend to have a little bit of complexity when it comes to naming them as beneficiaries are special needs children.
Specifically, children who are deemed disabled and incapable of self-support. The idea is having some sort of way to protect them and ensure that they get the money that their parents want to be able to leave to them without jeopardizing other benefits that they may have an entitlement to receive.
Leaving cash — like a TSP payment, a FEGLI payout or any of these other lump sum payments—directly to a special-needs child or adult may very well disqualify them from many other government benefits that they may otherwise receive. It’s important for anyone who has a special-needs child or adult to create a “Special Needs Trust” that helps to structure the assets properly as to not disqualify a special needs child or adult from being able to have these other services offered as well.
What Happens If I Have a Trust or a Will?
If you have a former spouse (or anyone else) listed as the beneficiary, they will receive that money regardless of what is stated in your will. That beneficiary designation will override anything that your will or trust says. These beneficiary designations are the most powerful legal documents that we, as laymen, can fill out by ourselves.
You must have a couple of witnesses, but you don’t need a notary or any lengthy court involvement. You don’t need an attorney. You don’t need a judge. You don’t need a court order. You don’t need any of those things; you can simply update them.
What Happens If No Beneficiaries Are Named?
From a legal standpoint, what happens to the money upon someone’s death if there’s no beneficiary listed? Believe it or not, this happens way too often.
There is a statute called The Statutory Order of Precedence and it is, by law, the order which your money is to be paid out if you did not indicate on a beneficiary designation who’s supposed to receive it. In lieu of you naming a beneficiary, one is going to be named for you based on this list through a court process called probate.
Probate is the court-supervised process that gathers a deceased person’s assets and determines the appropriate payments of assets which do not have a valid designation of beneficiary named.
The probate court pays out assets in this order:
- government debts, then
- creditors, then
- inheritors (see “Standard Order of Precedence” below)
If there is no beneficiary named, this is the order monies will be paid by the probate court to your inheritors as listed below:
- Your widow or widower, then
- Your child or children equally, and descendants of deceased children by representation, then
- Your parents equally or surviving parent, then
- The appointed executor of your estate, then
- Your next of kin entitled to your estate under the laws of the state you resided
The list seems pretty innocuous at the top and then it gets more convoluted the further down the list you go. In fact, the further down this list that you go, the less likely it is the person who you want to receive your money is actually getting your money.
Remember, assets are only “probated” if they do NOT have a valid designation of beneficiary on file at the time of your death. In other words, if you have a valid beneficiary designation, those assets skip probate and are paid directly to the person(s) you have named.
Another important aspect of probate is that the money doesn’t get paid out right away. It typically sits in probate for anywhere between 6 and 18 months. During that time, your family doesn’t have any access to it, so if you left that money for your family to be able to continue to pay a mortgage or to make sure your child still attended college, they don’t have the ability to use that money right away. Potentially, this puts them in an undesirable – and unnecessary – financial bind.
Another challenge of probate is that there are a lot of other entities who may be in line for your money before the court gets to your heirs in the Standard Order of Precedence. Namely, before your family gets paid any money, any government debts (like back taxes) and any creditors will be paid first.
Let’s say at the end of your life you racked up $300,000 of medical bills and you didn’t have a way to pay them. If you failed to name a beneficiary on benefits like FEGLI and TSP, that $300,000 is going to be paid from your assets by the probate court BEFORE your family receives anything.
Remember, the government and your creditors get first dibs on all the money that’s sitting in probate – which is not an ideal situation for your family.
The simple task of naming a beneficiary takes the guesswork out of the courts deciding where the money goes. Better yet, by naming a beneficiary, the money not only bypasses the probate process, but it’s also paid out immediately and not subject to any creditors. Creditors can’t come and take proceeds paid to a beneficiary. They simply they don’t have claim to those monies anymore. There are a lot of protections that simply naming a beneficiary can put in place.
The Most Common Beneficiary Who Is Named
The majority of federal employees contribute to the Thrift Savings Plan, and many will want to leave that money to their spouse upon their death – that’s the most common beneficiary designation that exists. It seems simple that you just name your spouse as the beneficiary, but the question is what happens next?
Upon the death of the TSP participant (you), the named beneficiary (your spouse) is going to receive the money in a separate TSP account called a “beneficiary account.” Your spouse will not be not able to contribute to this account, but can withdraw from it.
The spouse now gets to name his/her own beneficiaries, which is usually the children. However, upon the death of your spouse, all of the TSP money has to be paid out immediately in cash to the named beneficiaries in one single tax year.
All of that money to your children is going to be considered earnings for that particular year in which they receive it which means they’ll owe income tax on it. They can’t spread payments out over several years (like what is possible in an “Inherited IRA” in the private sector), so depending on the amount, it could be an extremely high amount of tax to have to pay.
So how can you avoid this? Upon the death of the federal employee, the spouse would need to move the money out of TSP to a special account, a private IRA.
Then, upon the spouse’s death, the children could receive their portion in an “Inherited IRA” and spread out the taxable cash they receive from this account over many years. This would prevent the children (or other named beneficiaries) from being hit with that large and immediate tax amount, so they get to keep more of the money that you intended for them to have.
Be Proactive and Keep Documents in a Safe Place
Updating your beneficiaries is so vitally important, but something that many of us don’t think about very often. The good news is that naming a beneficiary or even several beneficiaries is easy. As a reminder, you can go to our website at www.fedimpact.com/beneficiaries and find all the forms you need to update your beneficiaries today!
Be proactive in naming your beneficiaries and keeping them up-to-date as life changes along the way. Once you’ve updated them, keep a copy of the beneficiary documents in a safe place, so that your family knows that there is a benefit waiting for them if something should happen to you.
You’ve spent a whole lifetime earning these benefits, so you want to make sure that your loved ones get everything that’s due to them once you pass. Take the steps necessary to ensure that who you intended to protect actually receives the money upon your death.