Another Unpleasant TSP Surprise
YOUR BENEFICIARIES MAY NOT APPRECIATE THIS LITTLE KNOWN TSP RULE
Written By: Joseph Polakovic
As of September 2019, there were 5.6 million Thrift Savings account holders in the privately managed, Government-sponsored 401k. Prior to the TSP Modernization Act, more than 50% of people left the TSP upon retirement. It has yet to be seen how that number has changed since the Modernization Act went into effect, but it’s safe to say that continued participation in TSP after retirement remains a contentious topic. There are a myriad of reasons to look at alternatives to the TSP, and 401ks in general, and those reasons will vary from person to person depending on how you plan on living your retirement. However, one of the more uncharted problems that will apply to all TSP account holders is the implication for your beneficiaries upon your death.
Where Money Can Be Lost
It’s common knowledge you can designate beneficiaries but few people know what options your beneficiaries really have upon the primary account holder’s death. Let’s break it down.
If you pass away and your primary beneficiary is not a surviving spouse, they cannot retain a TSP account. Your beneficiary has 2 options, they can either take a full withdrawal, where there will be an automatic mandatory minimum 20% tax withholding (depending on the balance the recipient could be responsible for more taxes come filing time), or they can roll the money to an IRA.
If you are married and plan on leaving your money to your spouse, upon your death the TSP will establish a Beneficiary Participant Account in their name and the money will automatically be invested in a Lifecycle Fund most appropriate to their age. From there the surviving spouse can remain in the TSP, take a full withdrawal (traditional tax liability remains), or they can move the money to an IRA.
Well that doesn’t sound too bad for your spouse, right? The problem comes when the surviving spouse dies. Let’s say the surviving spouse remains within the TSP and has plans to leave whatever is left when they die to their kids. Upon their death, there is only one option for the kids or any other beneficiary at that point. They will be required to take a full withdrawal from the TSP where, again, the government will automatically withhold 20% tax and depending on the balance the recipients could have a more substantial tax bill come April. So essentially, if a surviving spouse remains in the TSP and passes, whomever he/she names as beneficiaries have no option other than to withdraw the full sum and potentially lose forever a significant portion to taxes.
TSP remains a wonderful accumulation tool while you are working and receiving a contribution match, but it can be riddled with disadvantages for federal employees nearing retirement. If you’re interested in discussing more of these reasons or have any questions, please contact us!