Posted on Saturday, 4th July 2015 by Dennis DampPrint This Post
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When a spouse is designated the beneficiary of a Thrift Savings Plan (TSP) account, the inherited account will be converted to the G-Fund upon notification of the death of the annuitant. The spousal beneficiary will be able to access and manage their inherited TSP account, select funds, and elect payouts just as before. No taxes would be due unless you withdraw funds or are required by age to take a minimum distribution.
The TSP’s Death Benefits brochure states on page 11 that, “A beneficiary who is not a surviving spouse cannot retain a TSP account. The death benefit payment will be made directly to the beneficiary or to an ‘inherited’ IRA.” There are distinct benefits for non-spousal beneficiaries to have their inheritance transferred to an inherited IRA. When a death benefit is paid directly to a beneficiary they may be subject to a 20% mandatory federal income tax withholding and the entire amount will be taxable in the year it was inherited. This may create a significant tax burden, depending on the account balance, that can be deferred if the funds are transferred to an inherited IRA with a financial institution such as a brokerage house, financial planning firm, or mutual fund family.
In my article titled “Survivor’s Beware – The TSP Trap“ I discuss what a surviving spouse needs to consider before moving their funds to a private equity firm, precautions they should take, the advantages of the Thrift Savings Plan, the ease of managing their TSP account, and recommendations to safeguard their TSP assets with little to no market risk. These same considerations should be evaluated by retirees and those approaching retirement who are often approached by financial planners with recommendations to move their funds from the TSP to higher market risk investments. There are also some disadvantages to consider for inherited spousal TSP account holders that could negatively impact their heirs.
I kept my TSP account in retirement because of the many TSP advantages that I discuss in the above mentioned article and in The TSP Advantage (Should I Stay or Go). I like the simplicity of the TSP, the lowest management fees in the industry, and the fact that the G-Fund has NO MARKET RISK and is paying a fair return, more than twice what the highest earning CDs are paying these days, 2.4% in 2014. When you consider the L-Income Fund, that has some market risk, pays close to twice what the G-Fund pays you can easily understand my reasoning.
There is one significant exception to this analysis. According to the TSP, “If a beneficiary participant (Annuitant’s spouse) dies, the new beneficiary(ies) cannot continue to maintain the account in the TSP. Also, the death benefit cannot be transferred or rolled over into any type of IRA or plan.” If you are the surviving spouse and inherit your husband or wife’s TSP account your beneficiaries must claim the full amount as income the year that you die.
TSP accounts, especially for FERS annuitants, can be hundreds of thousands of dollars and some exceed a million or more. Because your beneficiaries would have to claim all of that income the year it is inherited they could end up in the top tax bracket, depending on your account balance. The top tax bracket for 2015 of 39.6% starts at $413,200 for a single filer to $464,850 for a married couple filing jointly. If they were allowed to transfer the funds to an inherited IRA account they could spread out or defer payments for years.
If you have a spousal TSP account, and want your beneficiaries to have the option to transfer their inheritance to an inherited IRA account when you die, you can transfer your TSP account to an IRA with either a financial planner, brokerage house, or mutual fund family. If you transfer to an IRA account your heirs can, if desired, transfer their share to an inherited IRA and won’t have to claim the entire amount the year of the inheritance.
You can closely match TSP funds to private sector indexed funds with companies like Fidelity and Vanguard mutual funds or exchange traded funds (ETFs). Indexed funds generally have very low management fees, far less than managed funds charge and ETFs mirror the performance of many indexed mutual funds and they are traded like stocks. These two companies are the giants of the mutual fund industry and will assist you with the transfer and recommend funds that closely match the TSP fund options with some exceptions.
Most mutual fund families and brokerage houses can establish inherited IRAs for their clients however you need to be aware of front and back end loads (fees) that some mutual funds charge that can be as high as 5% or more. I don’t believe there are any mutual funds that can guarantee that your investment will never decrease in value like the TSP G-Fund does. However, there are many government bond fund options to choose from. You don’t have to invest in stocks or mutual funds. You can invest your funds in Certificates of Deposit, maintain a cash account, buy municipal bonds, U.S. Treasury bills, notes or bonds, corporate bonds of all types, or any other investment that you choose in an IRA.
I left instructions with our estate plan advising my wife to eventually transfer her spousal TSP account to an IRA so that our children can elect to transfer their inheritance to an inherited IRA when she dies. Eventually I may consider transferring my TSP account to an IRA so that my wife will not have to deal with this when I die.
My next article will discuss inherited IRAs and how they are established and function and a final article in this series will discuss indexed mutual fund alternatives to the various TSP funds.
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