You’ve heard the old saying “The Devil is in the details”, well the TSP is a great example of that. If you go to the TSP.gov website there are thousands of pages of information they expect you to know and understand. Even if you had the time, who would want to read that stuff? Well part of my job is to read the stuff that no to read and determine what parts of the information are useful to postal employees. One of the most disturbing parts I found pertains to taxation of a non-spouses beneficiary when a current or former employee passes on. I think it is very important and wanted to shed some light on the situation here.
1.) Taxes on your heirs: I always say in my seminars, “the good news is you work for the government, the bad news is you work for the government.”. What does that mean? Well you have a great paying job and benefits but you have to also remember that your employer is in the tax business and will create rules that benefit them as a result.
Let’s take John a postal employee who passes away and has $200,000 in his TSP. He has listed his only son as beneficiary. The money will pass to John but before he receives the money John will be taxed on the entire $200,000. If his son already has a job making $75,000 a year the $200,000 TSP inheritance will make John pay taxes as if he made $275k that year! Obviously, would this result in a higher tax bracket and in some cases reduces the amount heirs will receive by nearly 40% plus a reduction of whatever the son’s State Income taxes happen to be.
Now let’s look at this same situation if John had (at 59.5 or older or at retirement) rolled his TSP into a traditional IRA. Now when John passes his son can use what is called a “STRETCH IRA” to reduce the taxes he might owe. Using the Stretch IRA concept would allow a beneficiary to elect to receive either the full amount in the IRA or it allows them to “stretch” the payments out over their life expectancy. For example if John’s son is 45 the IRS will allow him to spread that $200,000 out over 45 years. In this example John’s son would only have to pay taxes on roughly $4,000 each year versus paying taxes on the lump sum like he would from the TSP.
The obvious question is why can’t the TSP stretch those payments like everyone else? In my opinion there are two primary reasons they won’t do it. First, they are in the tax business. Think about how many postal employees pass away every year. Think about how much TSP money is passing to heirs. That’s a huge stream of revenue for the government. Second, the TSP always brags about their low fees. Well along with low fees come fewer services and options. Because they collect very few fees, they are not willing to service the stretch payments to your beneficiaries.
If you are 59.5 or older or retired you can roll your TSP into a traditional IRA and offer your heirs the opportunity to take advantage of Stretch IRAs and other option the TSP does not offer that a Postal Benefits expert may be able to help you with. If you would like to learn more or have any questions please feel free to give me a call.
More from David Fielder
Postal Benefits Group