The Thrift Savings Plan is a Good Option
I like the Thrift Savings Plan (TSP). There are a lot of good reasons to invest in the TSP. A few of them are:
- Low expense ratios
- Tax advantages
- Access to the G Fund (not available outside of TSP)
But, you need to fully understand the estate planning ramifications, if you chose to have funds in the TSP.
If you designate beneficiaries, your TSP balance will be distributed as you desire. If you do not designate beneficiaries, then the funds will be distributed in accordance with (IAW) Federal law, regardless of what your will says. The funds will be distributed as follows:
- To your spouse
- To your child or children equally, and descendants of deceased children by representation
- To your parents equally or to the surviving parent
- To your appointed executor or administrator of your estate
- To your next of kin who is entitled to your estate under the laws of the state in which you resided at the time of your death
To make sure you don't end up with the funds distributed IAW Federal law or to someone you no longer want to receive the funds, I recommend you check your beneficiary designations once a year. Trust but verify when computers and humans are involved.
What Happens to Your Funds
When you pass, your funds will be distributed to the people you indicated on your beneficiary designation or IAW Federal law. Depending on who receives your funds and who they receive them from determines what happens with the funds.
- Spouse Inherits TSP. If you name your spouse as your beneficiary, there are two ways the funds can be distributed. In the first case, your spouse can establish a Beneficiary Account at TSP and the funds will transfer there. If this occurs, the funds will automatically be invested in the Life-Cycle Fund closest to your spouse's 62nd birthday. This may or may not be the best option for your spouse. Your spouse can reallocate the funds as he or she desires, but this will take time and effort. In the second case, your spouse can have the funds transferred to an inherited IRA (Traditional or Roth as appropriate).
- Non-Spouse Inherits TSP. If a non-spouse, such as a child, is the designated beneficiary, then the funds cannot remain in TSP. Like when a spouse inherits the TSP, there are two options. The first option is to have the funds rolled to an inherited IRA. In this case, there will not be any immediate tax ramifications. But, starting the next year, the beneficiary will have to start taking Required Minimum Distributions (RMD) and the distributions may be taxable depending on whether the TSP contributions were pre-tax, Roth, or tax exempt (from combat zone contributions). The second option is to take the funds out in a taxable transaction. Again, depending on the character of the contribution the distribution will be taxable, but not subject to age-based penalties.
- Owner of a Beneficiary Account Passes Away. This one really bothers me. To review, only a spouse can have a TSP Beneficiary Account. So if your spouse leaves the funds in TSP, this scenario will apply. When your spouse passes away, the entire balance will be paid out to the designated beneficiaries of the TSP Beneficiary Account in a one-time transaction subject to taxation (again depending on the character of the contributions). If there is a large, pre-tax balance, the tax burden could be significant and definitely will be greater that if the funds were in an inherited IRA and the RMDs could be stretched over many years.
As mentioned above, I like the TSP and I think most military officers should use it as an accumulation device. But when it comes to estate planning, I think you need to either leave specific instructions to your spouse to roll the funds to an inherited IRA when you pass away. Or, at some point after leaving the military, roll the funds into an IRA yourself.
The TSP is Different
If your advisor is not familiar with military benefits and the intricacies of the TSP, you should make sure he or she gains the knowledge to recognize the differences between military/government benefits and civilian retirement plans and employee benefits. If you're a do-it-yourselfer, then you need to keep up with the rules. Or, you could work with a financial advisor that deals with TSP, military and veteran's benefits every day.
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