TSP Inheritance vs. Inherited IRA Rules for Non-Spouse Beneficiaries

8.1.25: Audio automatically transcribed by Sonix

8.1.25: this mp3 audio file was automatically transcribed by Sonix with the best speech-to-text algorithms. This transcript may contain errors.

Speaker1:
Welcome back to the federal retirement Show. I'm your host, Val Majewski with American Benefits Exchange. I really appreciate you taking the time out of your busy schedule to join us to view our content to check out this episode today, because that's what we're here for. We're here for you, the federal employees out there that are looking for accurate information when it comes to your benefits and retirement situation. So hopefully you can avoid some of those mistakes that we talked about. You can set yourself up properly. You could be up to speed on legislation and some of the rules and all of the things that we've discussed. Now, I will say we've got over 140 episodes for you to check out. So if you like today's content, be sure to go back and view all of our other episodes. There's a lot, but I'm sure there's a topic in there that you have interested in that we've discussed in the past, and you can view that by going on YouTube. You can go to our website, which is federal retirement show. Com you can go on Spotify, SoundCloud, Apple Podcasts, wherever you listen to shows like this. You can find this on there. And I'll reiterate this at the end. But if you like this, like it. Subscribe. Get notified when we have a new episode and share it with your colleagues. There are other federal employees just like you who need this information as they need it, right? They don't just desire to hear it, they need to hear this stuff so that they can make the best decisions for their career.

Speaker1:
So share it with your colleagues. Let them know what's going on out there as far as education and training on benefits over time for federal employees. So today's episode, as we do on occasion, uh, I'm going to review an article that was written recently within the past week. And just I scroll through, I try to find, you know, what's out there, what's new, new legislation, new things that are that are going on. Just I came across this article because on, on occasion also we talk about TSP and we talk about, you know, opportunities with your TSP and how to set it up properly. And this article came about. When it comes to beneficiaries and specifically talking about the difference between a spousal beneficiary and a non spousal beneficiary, and what the rules are and the options are for those folks. So this was written on Fred smith.com. It was written by Benjamin Dirge. And I just want to give credit where credit is due. This is a great article informing you of the difference between spousal and non spousal beneficiaries with TSB and some of the other nuances, and I'm going to cover about half of the article. Feel free to go out and check the rest of it out, because there's some other information we're not going to get to, but we get asked this all the time, and I go over it with federal employees.

Speaker1:
When it comes to their TSB. You know what happens to my TSP when I pass? Obviously you're thinking about life insurance, your family or additional life insurances that you have. Yes, there's a death benefit that goes to your name beneficiary or beneficiaries. Same with maybe your pension, right? You've named your spouse as a beneficiary. Beneficiary. Then you got the spousal benefit that you elected. But what happens to TSP? And what happens if TSP will depend upon who you've named as the beneficiary. And you want to make sure you set them up right for success. So let's dive into today's article and I'm going to scroll through it. I'm going to read a little bit of it. I'm going to give you my commentary on it. But again this was on Fred smith.com written by a gentleman named Benjamin Berg. And I'm just talking about, again, the difference between the TSP inheritance and inherited IRAs, but also just about the difference between spousal beneficiaries and non spousal beneficiaries. So as we go through and I'm going to go relatively slow. So you can see this right. But when a federal employee it talks about making sure that you're setting yourself up for success and even your loved ones up or success when it comes to who's going to inherit your TSP.

Speaker1:
Now, obviously, your TSP is part of your retirement plan. It's one of the three main income sources for a first employee. You've got your pension, Social Security and TSB. That's what it was designed for. But perhaps TSP is not something you're looking to generate income from. Perhaps this is rainy day money. Perhaps it's money you want to just let sit and grow and you want to pass to your beneficiaries, if that's you. This is going to be very important to you. So primary beneficiaries of an inherited TSP account now primary versus non primary right. So what's a primary beneficiary. We're talking about a spouse here right. A primary beneficiary in general is a spouse. Now it could be underage children. It could be disabled children. But in general most of the time we're talking about a spouse. So if a spouse inherits your TSP versus a non spouse that's not considered a primary beneficiary inheriting your TSP. So let's scroll a little further here. And it's a non primary. Beneficiaries who inherit your TSP SP have 90 days to decide how they would like to distribute the cash before, subject to federal state taxes and disbursed. How do you want to distribute it now in general? Uh, people think about, you know, the, uh, TSP, if it's inherited by a non-primary or non spouse, that it's going to can be treated like an inherited IRA.

Speaker1:
And I'm going to share with you and you're going to show in this article that it is not the case. So when it's a primary beneficiary like a spouse, the spouse can actually take over the TSP account. They can treat it as if it's their own. And they can now create a spousal TSP account and they can leave it in TSP. They don't have to take the money out until it's RMD time. So that's a benefit of being a spouse or having your spouse as the primary beneficiary of your TSP, because it can go to them without the need to take it out to disperse the money. Okay. So it says this money. This is for non-primary non primary TSP beneficiaries. This money cannot be rolled over to an original IRA or an inherited IRA at this point, most likely leaving them with a significant tax burden, unlike funds in a traditional IRA. They must take a lump sum distribution from TSP. That can greatly be reduced by taxes, as seen in the infographic below. Now this is interesting. So let's look at it the way it's normally done. If your money was in a regular IRA traditional IRA, and it went to let's say a non spouse right a non spousal inherited IRA, what can be done there. Well this is where the money that's coming out can either be distributed in a lump sum by the beneficiaries.

Speaker1:
Let's say it's the adult children. In this case let's say it's the adult child. They can be distributed to them 100% if they wanted to, but they got to owe tax on it. Now, if they want to avoid that huge tax burden, that's going to come with it. Most people would say, I want to put it into an inherited IRA. Keep it tax deferred, at least for a little bit. And now the new inherited IRA rules say that you have to take that money out within a ten year period. That account has to be completely exhausted within a ten year period. That's not the case here with TSB. Even if the money is in a traditional portion of TSB, it cannot be transferred or treated like a traditional inherited IRA. That money has to be dispersed. So let's go through and I'll show you the example. Let's say Kelly is a female TSB account holder. Right. This is the regular employee or retiree that has the TSB and let's say Bob is the spouse. Right. Is the primary beneficiary, let's say a spouse. Okay. Bob inherits this or Rob sorry is listed on there. Inherits this. There's no taxes placed on the participant account because now they can keep it. They can keep it as their own. Okay, so if something happened to the federal employee, the spouse can keep the money in TSB, keep it as their own, and they're not subject to take the money out right away.

Speaker1:
And they're not subject to this big tax burden. But what if the money went to an adult son or Rather, it's a fully capable adult son. What would happen? David in this example inherits the money. In this example, $1 million, but receives the net amount after taxes, taxes are going to be withheld, and at that high of an account, that can be the highest taxes owed on that. Right. Because that's going to put somebody in a higher tax bracket. That $1 million is going to count as ordinary income for that calendar year, and they may only receive. And this is depending on the ultimate tax rate, things like that. But just under $600,000. This example 572,000. So a million goes in. And that's the big difference between a spousal beneficiary and a non spousal beneficiary from this is what they're going to receive and what they can receive over time. In this case the non spousal beneficiary the adult son would receive significantly less after all the taxes are paid on that lump sum. So not something that you definitely want to give in my opinion, that I'd want to give to my beneficiaries. If my beneficiaries are not a spouse, right? So this is a way in which you can understand the difference between a primary, as you're saying, or a non primary or a spousal and a non spousal beneficiary within TSP.

Speaker1:
So it's key to understand what your plan is going to be going forward. Because you want to ensure that your family, this money that you've set aside, this this nest egg that you've built up for your retirement, if you don't end up utilizing it and it passes to a beneficiary, you want to ensure that they can maximize it. They can use the most of it. They don't have the government. Uncle Sam taking the lion's share of it, or a very large share of it because of tax liabilities, and it wasn't set up properly. So here's the the idea or the concept that's talked about in this article, talking with an estate planner or a financial advisor or something that specifically works with federal employees could be very advantageous to setting this up properly. And one of the easiest ways to avoid this tax burden, In this immediate distribution that's going to happen to non spousal beneficiaries, is to withdraw your money out of TSB and put it into your own traditional or Roth IRA, depending on what bucket your money's in. Okay. So let's say let's look at the traditional money because that's the one that's subject to tax. The traditional bucket of your TSB, if it stays in TSB at the time of your passing and going to your beneficiaries, it's treated totally differently than if it was in a traditional IRA. Right.

Speaker1:
A traditional IRA can be inherited and traced to an inherited IRA. Now that person would have up to ten years to withdraw the entire account. And by doing that, they can limit the tax liability each year. Right. They can spread that out over the ten year period, and it's not going to be as great of a tax burden as the initial lump sum would be. Okay. So we can spread that out over a ten year period. Let's say you did 100,000 a year for ten years. Chances are that's not going to put this person in the highest tax bracket immediately. And it would lower their tax liability. They still get the same amount of money over time, but it would lower their tax liability during that time. Okay. Let's continue. Do inherited traditional IRAs differ from traditional IRAs? Now, inherited IRAs differ significantly. I'm going to read this a little bit. But unlike a traditional IRA where the account owner can make contributions and withdrawals. If you do get a traditional IRA. So let's say you move the money out of TSP and now it goes to your beneficiary as a traditional IRA. Um, or no, sorry. You move your money out of TSP into a traditional IRA, and now it gets inherited by your beneficiaries non spouse beneficiary into an inherited IRA. Yep. That's a going to be an easier move than if they get it directly from TSP.

Speaker1:
So I'm going to scroll a little bit further because there's something else you can do that can uh, definitely help you as far as limiting or eliminating or try to get rid of as much of the tax burden for your beneficiaries. Okay. So you are feel feel free. You will put the link here so you can read the entire article. But I'm going to scroll just a little bit longer here. And we're going to go into Roth IRA side of things. Right. So can a spouse convert an inherited IRA to a Roth IRA, or just think about Roth IRAs in general of your version of converting to a Roth? First of all, the Roth portion of your TSP, right? The portion of your TSP that is the tax free portion you pay tax in the money that you contribute today, that money grows, hopefully with interest, positive interest along with your future contributions. And in the end, that money can come out tax free. Right? It's Roth. It's already paid the tax on. It's tax free. It's not subject to RMDs. It's not subject to the same type of things as a traditional bucket or traditional IRA would. So when you retire or when you're eligible to, you can take your money out of your TSP. You put it into a traditional IRA of your choosing. There's so many different types of plans you can utilize, and you can start to convert any traditional portion from your TSB into Roth.

Speaker1:
And now that money will grow tax free going forward. Now what's the problem with this if there is one? Well, in order to convert from traditional to Roth, you have to pay the tax liability on the amount you convert it. And if you spread it out over time, then you can limit that tax liability over time too. But what's the positive in the end? All that money comes out tax free. It's now in a Roth plan. And if the money is inherited by your loved ones, it is still tax free. But they're not going to have a tax burden on it. Now there's a couple rules within Roth IRAs before any withdrawals need to be taken. That account needs to be set up for at least five years. Okay. Got it. Before any withdrawals of the interest, I should say, needs to be set up for at least five years. Okay, but what if the Roth IRA now is inherited? What's the difference? Well, the difference is if the Roth IRA is inherited, then the money still needs to be dispersed over a ten year period. But but there's no taxes due on this. So that's going to increase your tax liability. Okay. So it talks about here rules and advantages. When you inherit a Roth IRA there's not going to be RMDs owed. Any taxes owed that money would still be need need to be distributed or taken out within a ten year period, even though it's a Roth inherited IRA.

Speaker1:
Um, so just understanding that the way you set this up, it's great to, uh, build up your TSV. It's great to have it build with interest, take advantage of all the funds and all of these things, the matching money that the government gives you. But if you're not going to use it for yourself, if you're not going to set it up for lifetime income or, you know, draining all of that while you're alive, we don't know. Again, we don't have the crystal ball how long we're going to be alive for. So if you don't plan on using it all before you pass or setting it up for lifetime income or whatever, then make sure that it's set up properly for your beneficiaries. So we're not creating a tax burden for them as well. Now when we're looking at this, we've got that definition I mentioned earlier about kind of the designated beneficiary, the primaries versus those that are not primaries. Right. So we're talking about it says here this group includes surviving spouse, minor children of deceased minor children, disabled or chronically ill individuals, and beneficiaries who are not more than ten years younger than the IRA owner. These beneficiaries can take advantage of stretch IRA provisions. A totally separate conversation. But what we're talking about, if the primary verse is the non primary, I'll go back up to the top here.

Speaker1:
Uh, what I'm talking about today is really something that you want to make sure set up for the non spouse beneficiaries in your group. Right. The non spouse beneficiaries within your family or whoever you're naming in your TSP. So it's important to know who those are. If you haven't changed those in a while it's important to update those. Make sure that they know you have this and that. If something happened to you, this is a a part of your retirement plan that that they can then utilize. But you want to set your family up for success. As I mentioned, a spouse beneficiary in both the traditional or Roth sense. They have a little bit more advantage than, for example, your adult children that can inherit this money, and they're going to have a situation on their hands from a tax liability side. So talking to an expert, talking to somebody that deals specifically with TSP and federal employees, talking to somebody that helps retirees when it comes to setting up traditional IRAs or Roth IRAs or things of that nature, is very beneficial for you when you're eligible to do something and set your TSP upright. And the two ways that you can do that, or when you separate from service at any age, or if you're still working when you're at least 59.5 or older.

Speaker1:
Those are times in which you can now set up your TSP properly and ensure that your loved ones are taken care of if something happens to you and it passes on to them. So hopefully you found this beneficial. Hopefully, uh, this is not something that you're you're thinking your loved ones are going to take. Going to have happen to them because you've taken the time. You've talked to an expert and you've gotten your TSP set up properly. So you can check out the full article. We will include the link and read a little bit more about this. As I mentioned earlier. If you like our content, then get notified, subscribe and tell others about what we're doing and share us as much as possible. Right. We don't want you to keep us a secret. It's not just for you. This one individual that's watching. We want you to share it with everybody else because that's what we're here for. You can go to our website again, federal retirement Show. Com. If you want more information, you can fill out the form on the website. One of our experts, if it's not me personally, we'll reach out to you. We can go over your entire situation, not just your TSP and making sure that's set up right. So thank you again for taking the time out of your busy schedule, and look forward to seeing you on a future episode.

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