Difference between a contingent and a successor beneficiary ; image: extended family having a feast

Understanding the Difference Between a Contingent Beneficiary and a Successor Beneficiary

FEDZONE Ed Zurndorfer

Federal employees are advised to name beneficiaries for their retirement accounts including their Thrift Savings Plan (TSP), and any qualified retirement plan accounts such as 401(k) plans that they may own, traditional and Roth IRAs, and life insurance policies that they own including the Federal Employees Group Life Insurance (FEGLI), and an individual owned life insurance policies that they may own. There is unfortunately some confusion among the various beneficiary designation classes, two of which are “contingent” and “successor” beneficiary designations. This column discusses the difference between these beneficiary designations in order to clear up any confusion.

What is a Contingent Beneficiary Designation?

When a TSP participant or an IRA owner dies, the beneficiary form which the TSP participant or IRA owner completed and submitted determines who should receive the TSP or IRA funds, respectively. The beneficiary could be a person, a trust, a charity or any number of possible entities. When the TSP participant or IRA owner dies, the primary beneficiary is immediately deemed the new owner of these financial assets. Note that any type of retirement plan, including a 401(k), 403(b), a 457, SEP IRA, a SIMPLE IRA, the TSP and any type of IRA – traditional or Roth -is not a probate asset. That means no legal process must occur before the primary TSP or IRA beneficiary inherits.

However, if the primary beneficiary predeceases the TSP participant or the IRA owner, or if the primary beneficiary disclaims all or part of the inherited assets, then the next level of the beneficiary – the “contingent” beneficiary inherits the TSP or IRA funds. A contingent beneficiary in fact “moves up” to the role of primary beneficiary when the original primary beneficiary either dies or disclaims all or part of the retirement assets of the TSP or IRA funds.

Despite the importance of naming a contingent beneficiary, many TSP participants and IRA owners fail to do so. The same is true for naming beneficiaries of life insurance policies, including the FEGLI and individually owned life insurance policies.

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Failure to name a contingent beneficiary could lead to lost estate planning opportunities. If there is no named contingent beneficiary and the one-named primary beneficiary predeceases the TSP participant or the IRA owner, the TSP or IRA funds pass to the beneficiary named under the default language in the custodial document. This usually means that the TSP or the IRA custodian determines who receives the TSP or IRA assets respectively upon the death of the TSP participant or IRA owner. The named beneficiary is often the estate of the deceased IRA owner or TSP participant, which may not fulfill the intended wishes of the deceased TSP participant or IRA owner with respect to their retirement assets are to be distributed.

What is a “Successor” Beneficiary Designation?

If the sole primary beneficiary predeceases the TSP participant or IRA owner and funds remain in the TSP account or in the IRA respectively, then after the death of the TSP participant or IRA owner respectively only a contingent beneficiary can only acquire these funds. Account ownership for a contingent beneficiary is in many ways a “function of chance.”

However, when a “successor” beneficiary has been named, the successor beneficiary emerges after an account has already been inherited by the primary beneficiary. In other words, upon claiming the account of the deceased account owner, a primary beneficiary is advised to name his or her own beneficiary to receive his or her inherited assets after his or her death. In other words, when the primary beneficiary dies, the entities he or she named as beneficiaries of the inherited account are considered successor beneficiaries to the inherited retirement account.

An inherited IRA owner can name a successor beneficiary. However, when it comes to the TSP, a successor beneficiary cannot be named. The only way a successor beneficiary can be named with respect to the TSP is when a primary beneficiary of a deceased TSP participant who, upon inheriting the TSP account, requests that the entire TSP account be transferred to an inherited (“death”) IRA in his or her name. As an inherited IRA owner, the former TSP primary beneficiary can name a successor beneficiary to his or her inherited (“death”) IRA.

It has always been the law that any named beneficiary of an IRA (traditional or Roth) can, upon receiving the IRA account as an inherited IRA, name a successor beneficiary to his or her inherited IRA.

Unlike a contingent beneficiary who has no special payout rules, successor beneficiaries do have definitive guidance when it comes to required payouts from an inherited IRA. SECURE Act 1.0 (passed into law in December 2019) dictates that successor beneficiaries who are “non-eligible designated beneficiaries” (NEDBs) are bound by the “10-year payout” rule. If the primary beneficiary was using the 10-year payout rule (required for beneficiaries of IRAs in which the IRA owner died after December 31, 2019) then the successor beneficiary must continue to use the same 10-year payout window. If the primary beneficiary was stretching required minimum distributions (RMDs) over his or her own single life expectancy (applicable to beneficiaries of IRAs who died before January 1, 2020) then the successor beneficiary is permitted to start his or her own 10-year payout period. Additionally, the successor beneficiary must continue annual RMDs during years 1 through 9 of the 10-year term based on his or her primary beneficiary’s life expectancy. The following example* illustrates:

Jeanette died in 2020 at age 73. Jeanette had named her brother Winston, age 68, as her primary beneficiary of her traditional IRA. Since Winston was not more than 10 years younger than Jeanette, Winston was an eligible designated beneficiary (EDB) allowing Winston to take RMDs from his inherited IRA over his single life expectancy. Winston named his daughter, Sharon, as the successor beneficiary of his inherited IRA. Winston died in March 2023 at age 71. Sharon is subject to the 10-year rule and is required to withdraw the entire inherited IRA no later than December 31, 2033. During the 10-year period, Sharon must take annual RMDs in years 1 through 9, based on Winston’s single life expectancy. Note that Sharon’s first year RMD (for the year 2024) will be based on the inherited IRA balance as of December 31,2023 and Winston’s single life expectancy for a 72-year-old. This is because Winston would have become age 72 during 2024. From Table 1 in Appendix B of IRS Publication 590-B, the single life expectancy for a 72-year-old is 17.2 years. Sharon’s second year RMD (for the year 2025) will be computed based on the inherited IRA balance as of December 31,2024 and a life expectancy of 17.2 less 1, or 16.2 years. This RMD process will continue through year 9 (2032) and any remaining balance in the inherited IRA as of January 1, 2033 must be withdrawn by Sharon no later than December 31, 2033.

*This is a hypothetical example for illustration purpose only and does not represent an actual investment.

Federal employees and retirees with TSP accounts and IRAs are advised to make sure that they have taken the right steps in naming their TSP and IRA beneficiaries. If they have any problems or questions, they should contact an estate attorney who can answer any questions or address any particular problems associated with the proper naming of contingent and successor beneficiaries.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Difference between a contingent and a successor beneficiary ; image: extended family having a feast

Difference Between a Contingent and a Successor Beneficiary