Most federal employees are familiar with the rules for putting money into their Thrift Savings Plan but aren’t sure about taking money out. When thinking about the withdrawal rules for the TSP, it’s essential to differentiate between the rules while you’re a federal employee versus when you have separated from service.
Withdrawals made while you’re an active employee are called in-service withdrawals. There are two in-service withdrawal options: financial hardship and age-based withdrawal. In this article, we’re going to review the hardship withdrawal option.
What Are Financial Hardship Withdrawals?
A financial hardship withdrawal is one of the few exceptions that allow you to access your TSP before age 59 ½. However, you must have an immediate substantial financial need to use this option.
To qualify for a financial hardship withdrawal, you must have a financial need for at least one of the following reasons:
- Recurring negative monthly cash flow
- Medical expenses: Any medical expense that you have not yet paid that would be eligible for deduction on your federal income tax return (including household improvements needed for medical care).
- Personal casualty loss(es): Generally, these costs are identical to those that would be eligible for deduction on your federal income tax return.
- Legal expenses: Eligible legal expenses are limited to unpaid legal fees and court costs related to a separation or divorce from your spouse.
In addition to the eligibility rules, the following limitations will apply to the hardship withdrawal:
- You cannot withdraw less than $1,000.
- The withdrawal is limited to the lesser of your demonstrated hardship or the amount of your contributions and earnings.
- You are limited to one financial hardship withdrawal every 6 months.
- Your TSP contributions will continue unless you stop them.
- No documentation is required; however, when you complete your application, you will be required to certify, under penalty of perjury, that you have a genuine financial hardship.
Consequences Of Making A Financial Hardship Withdrawal
When you make a hardship withdrawal, you permanently reduce your TSP account by the amount you’ve withdrawn since you cannot return or roll over any of the withdrawal.
Thus, you give up any potential growth you could have experienced had you left the money invested in your TSP.
For example, if you take a hardship withdrawal of $20,000, that amount invested in the TSP for ten years at an average rate of return of 8 percent a year would grow to $43,178! That’s an opportunity cost of $23,178!
Hence, the missed growth opportunity is a significant cost you may bear when taking funds out of your TSP account.
Any time you withdraw money from your retirement account, there can be numerous tax implications. The exact impact of your hardship withdrawals will depend on whether you take them from your traditional or Roth TSP.
When taking withdrawals from your traditional TSP, you must pay federal and, in some cases, state income taxes on the entire portion of your withdrawal. Additionally, the 10% early withdrawal penalty may apply (some exceptions to the penalty include: attainment of age 59 ½, disability, and medical expenses exceeding 10% AGI).
On the other hand, when taking withdrawals from your Roth TSP, you won’t pay income taxes or the 10% penalty on the portion attributable to your contributions but will owe taxes and the penalty on any amount attributable to earnings if the distribution is nonqualified.
Note: Qualified distributions are from an account that has been held for at least 5 years, and the distributions must be made on account of the attainment of age 59 ½, disability, or death.
Consider A TSP Loan As An Alternative
A TSP loan can be a more efficient way to access emergency funds versus a hardship withdrawal.
For one, a hardship withdrawal permanently depletes your account, while a loan can be repaid.
Moreover, you can take a general-purpose loan for any reason, while hardship withdrawals are limited only to the reasons previously covered.
Lastly, if you repay the loan, there are no tax implications! You can learn more about the TSP loan here.
Since the TSP is a key component of your federal retirement benefits, it will likely represent a significant portion of your retirement income. Therefore, it’s imperative that you explore all your options before tapping into your account; since doing so may not only jeopardize your retirement but also might have significant adverse tax implications.
A possible alternative is a TSP loan, which could provide access to funds quickly and, if paid back, would help you avoid a tax bill or penalty. This method would also keep you from reducing your retirement account.
Although I strongly advocate for every federal employee to maintain an emergency fund, life happens, and some of us may find ourselves in a situation when we need access to funds quickly. If you need help creating your financial plan or just want to make sure you are not missing anything, consult a qualified financial planner.
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2023 Legislative Change Notice
The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.