If you Google the phrase “died penniless,” you’ll get over 1,000,000 results. Famous people on the list include Oscar Wilde, Joe Louis and Judy Garland. While it’s tempting to try to arrange things so you spend your last dollar the day before you die, it’s almost impossible. Most of us will die with money in the bank or some investment vehicles. But before your beneficiaries start thinking about what they’re going to do with the money, they have to consider the dreaded taxes that they may have to pay. These taxes include estate taxes, inheritance taxes and income taxes.
This is particularly true if your mother, father or partner was a Federal government employee, who was a participant in the Thrift Savings Plan (TSP). When a participant in the TSP dies, the government will begin trying to locate the beneficiaries. (If the deceased did not name a beneficiary, the TSP plan has a statutory order of beneficiaries, which may or may not be what was desired).
Once they are located, the TSP sends the beneficiaries a form called the called the TSP-17 (to claim the benefit of a deceased participant) as well as a letter informing them of their options – accept the benefits outright or transfer the benefits to an inherited IRA.
If a beneficiary fails to respond, by default the TSP will pay the entire benefits outright to the beneficiary within a 60 day period, in which case the beneficiary then has to report the entire TSP plan benefits in his or her income tax return and pay income tax immediately. On the other hand, if the beneficiary responds to the letter from TSP indicating that he or she wants to transfer the benefits to an inherited IRA (and provides all of the right information), then instead of immediate income taxation, the benefits can be paid out over the beneficiary’s lifetime.
The problem is that there are no second chances. Once the check is sent by TSP, the game is over. If the forms are not completed, or filed incorrectly, there is no recourse. Distributions from retirement plans are very complicated and confusing for most people. For these reasons, I generally believe that is incredibly important to run, do not walk, to get legal and tax advice after your mother, father or partner dies. The only way to insure that the right choices are made is to seek the appropriate legal and tax advice. Doing so can save you thousands of dollars and allow for the continued tax deferred compounding of the portion of your relative’s TSP that was left you.