Managing Money

The SECURE Act and the Thrift Savings Plan

In 2019, Congress passed the SECURE Act, which introduced the new 10-year rule many beneficiaries must now follow when inheriting a retirement plan. For most retirement plans, the rule took effect January 1, 2020; however, the law carved out an exception and delayed the effective date until January 1, 2022, for governmental plans, including 403(b) and 457(b) plans sponsored by state and local governments, and the Thrift Savings Plan (TSP).

In the era before the SECURE Act, beneficiaries were broken down into one of two broad categories—designated beneficiaries and nondesignated beneficiaries. A designated beneficiary is a living human, whereas a nondesignated beneficiary is a nonperson such as a nonqualified trust, a charity or an estate. The SECURE Act further divided designated beneficiaries into two subgroups: eligible designated beneficiaries and noneligible designated beneficiaries.

Before 2020, designated beneficiaries inheriting a retirement plan had the option of taking required minimum distributions (RMDs) over his or her own life expectancy, a strategy known as the “stretch IRA.” The SECURE Act, however, eliminated the stretch option for the group of designated beneficiaries falling into the noneligible designated beneficiary subgroup; it now requires them to follow the 10-year rule.

Unlike beneficiaries utilizing the stretch strategy, which requires the beneficiary to take a minimum distribution each year, the 10-year rule has no annual RMDs. Instead, the

THE SECURE ACT DEFINED FIVE GROUPS OF ELIGIBLE DESIGNATED BENEFICIARIES— THOSE WHO ARE EXCLUDED FROM THE 10-YEAR RULE AND WHO MAY STILL UTILIZE THE STRETCH STRATEGY.

10-year rule simply requires the inherited retirement plan to be fully liquidated within 10 years after the year of the plan owner’s death. For example, a noneligible designated beneficiary who inherits a retirement plan in 2022 will have until December 31, 2032, to fully distribute the inherited account.

The SECURE Act defined five groups of eligible designated beneficiaries—those who are excluded from the 10-year rule and who may still utilize the stretch strategy. The five groups are: spousal beneficiaries; disabled beneficiaries (as defined by IRC Section 72(m) (7)); chronically ill beneficiaries (as defined by IRC Section 7702B(c)(2), with limited exception); beneficiaries not more than 10 years younger than the decedent; and certain minor children of the original retirement account owner.

Even though the SECURE Act’s 10-year rule has applied to most retirement plans since 2020, it didn’t apply to the TSP until January 1 of this year, which means that even noneligible designated beneficiaries who inherited a TSP in 2020 or 2021 were still permitted to employ the stretch IRA strategy.

Although the SECURE Act allows noneligible designated beneficiaries to take up to 10 years to distribute an inherited retirement plan, it doesn’t mean that they will be able to keep an inherited TSP account in the TSP for up to 10 years. That’s because the Act didn’t change the TSP’s death payment rules for beneficiaries.

Under TSP rules, only a spouse inheriting from the original TSP participant may maintain a beneficiary participant TSP account. A nonspouse beneficiary’s only option is to take a lump-sum distribution, which may be paid directly to the beneficiary (and will be fully taxable to the extent

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the distribution comes from the traditional TSP), or transfer the distribution directly to an inherited IRA.

In other words, if a nonspouse designated beneficiary (either eligible or noneligible) wishes to preserve the tax benefits of the inherited TSP account for as long as legally permissible, he or she will need to transfer the inherited TSP to an inherited IRA—either traditional, Roth or both, depending on the type of TSP account balance being inherited.

It’s important to point out that the SECURE Act didn’t impact the TSP rules applying to a beneficiary inheriting a beneficiary participant TSP account (which only the surviving spouse of the original TSP participant may maintain). In this case, the beneficiary participant TSP account will be paid out directly to the beneficiary as a lumpsum distribution. The beneficiary of a beneficiary participant TSP account doesn’t have the option to transfer the distribution to an inherited IRA, which means all tax benefits are lost following the death of the beneficiary TSP participant.

The SECURE Act has major implications for retirement plan beneficiaries. Be sure you and your beneficiaries understand the rules.

MARK A. KEEN, CFP®, IS PARTNER, KEEN & POCOCK, AND AN INVESTMENT ADVISER REPRESENTATIVE AND REGISTERED PRINCIPAL OF THE STRATEGIC FINANCIAL ALLIANCE INC. (SFA). SECURITIES AND ADVISORY SERVICES ARE OFFERED THROUGH SFA.

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