Every service member who entered after 2018 has a Thrift Savings Plan account, and so does every retiree who opted in before that. For a 45-year-old who retired as an E-7 or an O-4, it's often the largest single asset in the household, larger than the home equity and much larger than the life insurance. It's also the asset estate plans handle worst, because it follows rules that no will, trust, or probate court can override, and one of those rules sets a trap that springs on the second death, not the first.
Rule one: the form wins
The TSP pays to whoever is named on the beneficiary designation on file with the plan. Not the will. Not the trust. If the form on file names your ex-wife from 2011, your ex-wife from 2011 gets the account, and your current spouse's remedy is a lawsuit against her, not against the plan. Courts have upheld that result repeatedly, because federal law says the plan pays the designation and the plan has no duty to know your life changed.
If there's no form on file, the plan pays by a fixed order: spouse, then children equally, then parents, then the estate, then next of kin. That order is fine for a first marriage with no complications. It's wrong for nearly everyone else, and it puts the account into probate, with the estate's creditors in line, for anyone whose spouse and children have already died.
The fix is five minutes and a signature. Check the designation on file. Update it after every marriage, divorce, birth, and death.
We
say this in every estate planning post because it's the most common way a good plan fails, and the TSP is the account where the failure is most expensive.
Rule two: the spouse gets a special account, and that's where the trap is set
When a TSP participant dies and the spouse is the beneficiary, the plan doesn't pay out. It converts the balance into a beneficiary participant account in the spouse's name: same investment funds, same low costs, same tax deferral, no required withdrawals until the spouse's own required age. For the surviving spouse, that's a good deal, and most take it.
Then the spouse dies. Almost nobody is told this at the first death: when the holder of a beneficiary participant account dies, the money is paid to that holder's beneficiaries as a lump sum, and it cannot be rolled into an inherited IRA. The entire balance becomes taxable income to the children in the year they receive it. A $600,000 account that would have been stretched over ten years in an inherited IRA, taxed at the children's ordinary rates as it comes out, is instead taxed all at once, at the rates a $600,000 windfall puts them in.
That's the trap. It doesn't exist for a private 401(k), where the spouse can roll to her own IRA and her heirs can then inherit an IRA. It's specific to the TSP, it's written into the plan's rules, and it's avoidable only by the spouse acting during her lifetime.
How to avoid it
The surviving spouse has the choice, at the first death and any time after, to roll the beneficiary participant account out of the TSP and into her own IRA. Once it's in an IRA, the normal inherited-IRA rules apply at her death, and the children can spread the withdrawals over the ten-year window the law allows. The trade is that she gives up the TSP's funds and its expense ratios, which are hard to beat. For a spouse in her 50s with a large balance, the math usually favors the rollover anyway, because the tax on a forced lump sum at the second death dwarfs the fee difference over a decade.
The estate plan should say this. Not in the will, which can't bind the TSP, but in the letter of instruction and in the conversation with the spouse: when I die, talk to the financial adviser about rolling the TSP out before you name your own beneficiaries on it. A one-line note is the difference between a tax-deferred inheritance and a taxable one.
Rule three: non-spouse beneficiaries get a different clock
If the beneficiary isn't a spouse, a child, a sibling, a trust, the plan doesn't create a beneficiary participant account. It pays the balance out. The beneficiary can take the cash, taxable, or have it transferred directly to an inherited IRA, which preserves the deferral and starts the ten-year clock. The transfer has to be set up as a direct rollover with the plan; a check made out to the beneficiary is a taxable distribution and the chance is gone.
For a trust as beneficiary, which some veteran households use to
protect a child on benefits or
to control a minor's inheritance, the plan pays the trust, and whether the trust can then stretch the withdrawals depends on how it was drafted. A trust written without the TSP in mind can force the whole balance out in one taxable year. If the TSP is going to a trust, the trust has to be built for it.
The Roth question
TSP balances can be traditional, Roth, or both. The Roth portion passes income-tax-free to the beneficiary, and the lump-sum rule at the second death still pays it out but doesn't tax it. For a retiree with both, the designation can't split them; the beneficiary gets a proportional share of each. That's one more reason the rollover-to-IRA conversation belongs in the plan, since an IRA can hold the Roth and traditional pieces separately with different beneficiaries if that's what the family needs.
Where we come in
We're a veteran-led firm, and the TSP is on the checklist for every estate plan we build for a retiree household, along with the SGLI form,
the SBP election, and the deed. If you've never checked the beneficiary on file, or nobody's told your spouse about the second-death rule,
reach out.
