Q. Let’s suppose I have a TSP account balance of $300,000, and when I die I leave the $300,000 to my spouse in a beneficiary participant account (BPA). She then sets it up so the two children we have are beneficiaries in equal shares. When she passes, my understanding according to TSP rules is the children cannot transfer the money into an inherited IRA to minimize their tax consequences. The money will have to be paid out in equal shares to the children and be fully taxable.
I was told that in this case the spouse should transfer the money out of the BPA and into a traditional IRA. Then the spouse can set up inherited IRAs so when she dies, the children can stretch out the distributions over their lifetimes, thus minimizing their tax consequences. Does this make the TSP BPA less desirable? Also, if my spouse dies before I do, should I at some point transfer my TSP funds to a traditional IRA so my children won’t be faced with the same big tax hit in that particular scenario? I had also heard that you need to set up trusts for the children on the TSP-3 form in order to prevent the huge tax bite in these cases.
A. Your questions go beyond the scope of this forum and into the realm of estate planning, which should be done individually with the help of a qualified attorney. You are correct about the TSP’s rules, but I think that you may be attaching far too much importance on the value of continuing tax deferral.
First, you need to acknowledge and quantify the tax liability that already exists against the TSP money. Tax liability isn’t created when the TSP distributes funds — an existing liability is realized. Your decision making should involve comparing the liability under various scenarios rather than comparing the realized liability to zero.
Second, you should compare any advantage that might be obtained from continuing deferral — if there is any — to the costs of leaving the TSP for an IRA, which would likely include higher costs and greater risk, and will definitely include loss of access to the G Fund.