The Importance of Naming a Successor Beneficiary to TSP and IRA Accounts

Thrift Savings Plan (TSP) participants are highly encouraged to designate beneficiaries of their TSP accounts. Any person, a trust or a legal entity/corporation can be named as a beneficiary. More than one individual, trust or legal entity/corporation can be named as a TSP beneficiary with each beneficiary’s share entered as a percentage.

An important question that needs to be considered by TSP participants when designating their TSP primary beneficiaries is what happens if the primary beneficiary predeceases the TSP participant. If the TSP participant does not name another beneficiary, then the deceased’s beneficiary will then be split evenly among the other remaining beneficiaries.

The following example illustrates:

Lauren is a federal employee with a TSP account. She has made the following TSP beneficiary designations:

(1) her husband Mark, 50 percent share;
(2) her son Charles, 25 percent share; and
(3) her daughter Phyllis, 25 percent share.

If Mark predeceases Lauren, then unless Lauren makes another primary beneficiary designation, both Charles’ and Phyllis’ beneficiary share percentage will automatically increase to 50 percent apiece. This is because Mark’s beneficiary percentage of 50 percent is divided in half – 25 percent is given to Charles and 25 percent is given to Phyllis.

Another way to make sure a person, trust or a legal entity/corporation receives the TSP participant’s account in the event that a primary beneficiary predeceases the TSP participant is to name a contingent beneficiary for each primary beneficiary. The contingent beneficiary whom the TSP participant names will receive the portion of the TSP account that was designated for a specific beneficiary who dies before the TSP participant dies.

Consider the example above:

In addition to naming her primary TSP beneficiaries, Lauren named contingent beneficiaries as follows: (1) for her husband Mark, her sister Louise (50 percent); (2) for her son Charles, her nephew Robert (25 percent); and (3) for her daughter Phyllis, her niece Suzanne (25 percent).

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What happens when the TSP participant dies and each of the designated beneficiaries receives his or her percentage share of the deceased TSP participant’s account? Can the designated beneficiaries, in turn, name successor beneficiaries for their inherited TSP accounts? The answer depends on whether the named beneficiary is a spouse or a non-spouse.

With a spousal TSP beneficiary, a surviving spouse has the option of keeping his or her inherited TSP account* in the TSP. The spousal beneficiary is not required to withdraw the inherited TSP account within a certain period of time, as is the case with non-spousal TSP beneficiaries. Nor does the spousal beneficiary have to rollover the inherited TSP account to an IRA. The spousal TSP beneficiary can leave his or her inherited TSP account in the TSP and establish what is known as a “beneficiary” TSP account. The spouse is then called a “beneficiary” TSP participant. As such, a beneficiary TSP participant has the same rights as a separated TSP participant with respect to withdrawal options, inter-fund transfers, being subject to the required minimum distribution (RMD) rules each year once they become age 72, and naming primary beneficiaries of their beneficiary TSP account.

*The value of the inherited TSP account must be at least $200

In the example above, when Lauren dies, Mark can keep his 50 percent inherited portion of Lauren’s TSP account in the TSP as a beneficiary TSP account. As is explained next, Lauren’s two children, Charles and Phyllis do not have the option of establishing a beneficiary TSP account.

What Are the Options for Nonspousal TSP Beneficiaries?

A nonspousal beneficiary of a TSP account does not have the same options of what to do with their inherited TSP account as does a spousal TSP beneficiary The rule is that a nonspousal beneficiary of a TSP account – such as a child – must withdraw his or her inherited traditional and/or inherited Roth TSP account within five years of the death of the TSP participant. At the fifth-year anniversary date, the TSP will distribute any remaining bequeathed TSP assets to the named nonspousal beneficiary.

In order to minimize the tax consequences of having to withdraw the inherited TSP assets within five years of the TSP participant’s death, especially with the traditional TSP in which distributions are fully federal and state taxable, a nonspousal beneficiary has the option of requesting a direct transfer of their inherited TSP assets to an inherited (“death”) IRA. A traditional TSP account could be directly transferred to an inherited (“death”) traditional IRA while a Roth TSP account could be directly transferred to an inherited (“death”) Roth IRA.

There are rules associated with inherited (“death”) IRAs that individuals who own them should be aware of. First, the individual cannot contribute to an inherited (“death”) IRA like the individual can contribute to a “contributory” IRA. Second, the individual must start withdrawing from the inherited (“death”) IRA, starting the year after it is established. This is true whether it is a traditional or a Roth inherited (“death”) IRA.

Before the passage of the SECURE Act on Dec. 19,2019, those individuals who were the owners of an inherited (” death”) IRA had the option of spreading the withdrawals from their inherited IRAs over their life expectancy. For example, a 35-year-old person with a life expectancy of age 85, who established an inherited IRA would have 50 years to withdraw the account, with payments each year based on life expectancy.

The passage of the SECURE Act changed the inherited (“death”) IRA rules. Effective Jan. 1, 2020, any inherited IRA owner who is not an “eligible designated beneficiary” (EDB) must withdraw the inherited IRA assets within 10 years of the date that the inherited IRA was established. An EDB includes a spouse and a sibling with 10 years of age of the qualified retirement plan (and the TSP) participant or an IRA owner. An adult child is therefore not an EDB.

This means that for any TSP participant who dies after Dec. 31, 2019, and who has named an adult child as a beneficiary, the adult child can request that the TSP directly transfer the child’s inherited IRA assets to an inherited (“death’) IRA. Once the TSP assets are transferred to the inherited (“death”) IRA, the adult child must withdraw the TSP assets within 10 years**. Of course, this means that federal and state income taxes would have to be paid on inherited TSP assets being withdrawn from the inherited (“death”) IRA. In short, an adult child has an extension of up to 10 years to withdraw their inherited TSP accounts. The same rules apply for inherited Roth TSP assets transferred to an inherited (“death”) Roth IRA. The difference with an inherited Roth TSP account is that no federal and state income taxes would be due on its withdrawal. The inherited (“death”) Roth IRA owner can wait until the end of the 10th year to withdraw the inherited Roth TSP assets and not pay any federal or state income taxes.

** Of the day of death of the TSP participant

The question now becomes; Can an inherited (“death”) IRA owner name a successor beneficiary? The answer is yea. However, the successor beneficiary does not get a new 10-year payout for what remains of the inherited (“death”) IRA original beneficiary (who established the inherited (“death”) IRA after the death of the TSP participant. The account must be emptied by the end of the 10th year after the day of death of the TSP participant. The following example illustrates:

On January 10, 2020, Arnold inherited $100,000 of a traditional TSP account from his father Charles, who was a federal annuitant with a TSP account at the time of his death. Arnold requested that the TSP directly transfer Arnold’s $100,000 inherited TSP assets to an inherited (“death”) traditional IRA that he established at a brokerage. Arnold named his brother and sister as 50 percent successor beneficiaries of his inherited (“death”) IRA.

Arnold was well aware that he had until January 10, 2030 – the 10-year anniversary of his father Charles’s death – to withdraw his $100,000 inherited TSP assets that are in an inherited/death IRA. Arnold was tragically killed in an automobile accident in April 2021. Arnold’s brother and sister must withdraw what remains of the inherited (“death”) IRA no later than January 10, 2030.

Transitioning inherited TSP assets from one nonspousal beneficiary to another beneficiary has never been an easy task. Prior to the passage of the SECURE Act (pre-2020), a nonspousal TSP beneficiary could have elected to directly transfer inherited TSP assets to an inherited (“death”) IRA and elected to withdraw the inherited TSP assets over their life expectancy.

The passage of the SECURE Act expedited the 10-year payment window. This will accelerate the tax schedule of an inherited “death”) traditional IRA. That is, funds with traditional TSP assets. But the 10-year withdrawal deadline is flexible in the sense that the inherited (“death”) IRA owner can withdraw any amount annually over the 10-year period. There are no annual required minimum distributions during the 10 period. Therefore, proper tax planning is imperative. In the case of the inherited (“death”) Roth IRA, the owner does not have to withdraw the assets until the end of the 10th year. Since there are not taxes due, delaying the inherited Roth IRA withdrawal as long as possible will allow for the maximum tax-free compounded growth of the account.