TSP Beneficiary Forms – What You Need to Know

It may be hard to believe – but there is bad advice on the back of the TSP beneficiary forms. The form says you should leave your beneficiary blank – Let me tell you why this is bad advice and what you should do about it.

There is a rumor going around that encourages federal employees to leave their TSP beneficiary forms blank if they want their TSP to go to their spouse when they pass away.

Even the TSP paperwork suggests this. But I could not disagree with this more. Here’s why…

What Happens if Your TSP Beneficiary Forms are Blank?

If you die, and you don’t have a beneficiary listed on your TSP beneficiary form… Where does the money go?

That’s the question – and the answer depends on a number of factors. And there are lots of ‘What-If’s’.

In the simplest case, if your spouse is still living – your spouse will very likely get the money from your TSP account even if you didn’t list them as a beneficiary.

In most situations, the TSP will be converted into an inherited IRA. The money still keeps its tax-deferred status, but your spouse will have to start taking Required Minimum Distributions (RMDs) based on YOUR life expectancy. (Which is a little ironic, since in this scenario you’ve already passed away – but that’s just part of the tax rules.)

So, in this example, your spouse still got the money even though they weren’t listed on a beneficiary designation.

But Was It the BEST Option?

But was this really the BEST option for your spouse?

Maybe… maybe not. One thing is certain – when you leave your beneficiary form blank – you are limiting your spouse’s choices.

When we cover this topic in my classes, sometimes federal employees will say, “But look – the spouse got the money even when the TSP beneficiary form was blank. Why should I fill out the form?”

I tell them that it all works fine if there are absolutely no hiccups along the way. But even then – there may be better choices for you and your spouse.

There are 2 big reasons I think you should consider naming beneficiaries on your TSP beneficiary forms…

#1) To Give Your Spouse / Heirs Choices

Ideally, you should name primary and contingent beneficiaries on your TSP beneficiary form. And with proper planning – you can give your spouse and heirs flexibility and choices.

One option that might make sense is to list your spouse as the primary beneficiary, and your children or grandchildren as your contingent beneficiaries.

Now if you pass away, your spouse can accept the money – or – if your spouse doesn’t need the money, they could disclaim it and have it go to your children or grandchildren… but ONLY if they are listed as beneficiaries.

And your children or grandchildren have choices… they could take the money in a lump sum and have one heck of a party – but pay tons in taxes. They could take the money out over 5 years, or they can take the money out over their life expectancy and have what we call a Stretch IRA. They ‘stretch’ the money out over their life time, and this is generally the way to pay the least amount of taxes on the money.

Now, if you want ‘make’ your children or grandchildren do a Stretch IRA, you’ll want to look at getting a good trust put together that specifies that.

This is why many federal employees have a trust put together – so they can specify what happens with their money after they’ve passed away.

Trusts Can Give YOU the Control… But…

Many federal employees have trusts set up for their estate. In some cases, it makes sense to list their spouse as their primary beneficiary, and their trust as the contingent.

Now, if the federal employee passes away – and the TSP beneficiary form was filled out correctly - the spouse has choices. The spouse can accept the TSP money into an inherited IRA - or – they could disclaim the money, and have it go to the trust.

***We can only go so far into talking about trusts here – but I do want to make an important note here that if you wanted to think about that option – it is VERY important that you have your trust set up properly. Many trusts are not set up to get the most favorable tax treatment of retirement accounts. In fact, I would say that 90% of the trusts I’ve seen from federal employees are set up in a way that might make the heirs pay MORE in taxes than is necessary.***

#2) To Avoid Probate & Pay Less in Taxes

While the back of the TSP beneficiary form lists a standard pecking order of who gets your TSP money – when you leave your beneficiary form blank - you can’t rule out the possibility of Probate. And Probate means legal fees, court involvement and possibly very high taxes.

When your TSP goes through probate, it loses its tax-deferred status and the entire amount is subject to ordinary income tax right away.

Let’s Look at an Example…

Say your TSP was worth $500,000 when you passed away. If you did not list a beneficiary and it goes through Probate, your TSP account will lose its tax-deferred status.Now 100% of your TSP account is subject to ordinary income tax (both Federal and state income taxes). Under current law, the highest federal income tax bracket (at approximately $373k – Married Filing Joint) is 35%.

Now of that $500,000 – at least $145,000 (it depends on how much other income your heirs had) will get eaten up by Federal taxes – leaving your heirs with approximately $355,000. Or even less if your state has income taxes.

Could they have paid less in taxes? With good planning – there is a very good chance they could have paid a lot less in taxes. But since you didn’t list a beneficiary in this example – the answer is no.

Now, if you had listed a beneficiary, they would have been able to choose how to receive the TSP money. And with good planning and guidance they could reduce the amount they pay in taxes.

Bottom line: Your beneficiaries have choices; and with proper planning, they can pay less tax and keep more of the money… But ONLY if they are named as beneficiaries.

If you’re going to leave your beneficiary form blank, you might as well just fill in ‘Uncle Sam’ – because that’s who benefits when you don’t list a beneficiary.

"Does the TSP Form Really Say That?"

Yes. The TSP Beneficiary Form really does encourage you to leave the beneficiary form blank. If you look at page 2 of the TSP-3 form it says…

It is necessary to designate a beneficiary only if you want payment to be made in a way other than the following order of precedence:
1. To your widow or widower.
2. If none, to your child or children equally, and descendants of deceased children by representation.
3. If none, to your parents equally or to the surviving parent.
4. If none, to the appointed executor or administrator of your estate.
5. If none, 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.

So a lot of federal employees read the form, and decide that they don’t need to complete the form because they want their TSP to go to their spouse.

And that is really too bad – because their spouse and heirs would be better off if they were listed on the beneficiary form.

“But Why Would They Say That?”

When federal employees learn about this – they often ask me, “Micah – why would TSP tell us to do that?”The Answer: TSP was only thinking about their part of ‘the pie’. They didn’t understand estate planning or tax consequences.

Think about it, to someone who only works with the TSP – those instructions seem to make perfect sense. And indeed – if you didn’t fill out the TSP beneficiary form, your spouse will probably get your TSP if there are absolutely no hiccups in the process.

But it’s not the BEST advice.

Often times, you may get advice that makes ‘total sense’ when it comes to one aspect of your federal benefits. But it may not be the BEST advice for you when you look at how it will affect your broader financial picture.

So that’s the question: Does the person giving you advice really understand your broader financial and tax situation?

This is where a good financial planner comes in. A good financial planner looks at ALL of the pieces of the pie and how they work together. They help you with your federal benefits, estate planning, tax strategies and investments.

What Should You Do?

The first thing to do is make sure you have filled out the TSP Beneficiary Form.

As a Federal Employee, you have FOUR different but important beneficiary forms to fill out (including the TSP beneficiary form).

Take time to review your beneficiary designations. Don’t put this off any longer. Get this taken care of – TODAY.

Contact your HR department and ask to see your current beneficiary designations. And if needed, get the forms to update them at that time.

Be sure you ask for all FOUR of your beneficiary designations. I recommend that you list a primary beneficiary, as well as contingent beneficiaries.

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Micah Shilanski, Financial Planner for Federal Employees