Many federal employees are unfamiliar with the Thrift Savings Plan’s withdrawal options, and for good reason, the list of terms and rules for making contributions and taking withdrawals can seem endless.
Adding to the confusion is that there are different withdrawal rules for active and separated federal employees. So, to help shine some light on the topic, this week, we’re discussing the withdrawal options for active federal employees, which are called in-service withdrawals.
Excluding the TSP loan, active federal employees have two options for withdrawing from their TSP: the hardship and age-based withdrawal options.
Since we’ve covered the hardship withdrawal in a previous article, we’ll focus on the age-based withdrawal this week.
What Is An Age-Based Withdrawal?
If you’re an active federal employee age 59 ½ or older, you can withdraw a portion or all of your vested balance from your TSP account. Unlike a hardship withdrawal, the age-based withdrawal does not require a financial need, and your withdrawal will not incur the 10% early withdrawal penalty.
To make an age-based withdrawal, you must be an active federal employee, have reached age 59 ½, not have made a withdrawal within the last 30 days or more than four within a calendar year, and your withdrawal must be $1,000 or more.
An important point to remember is that your withdrawal is limited to your vested account balance. This means the portion of your account that you’re entitled to; this always includes your contributions, the growth on those contributions. Generally, your agency’s match and growth are vested after three years of service.
If you have both a traditional and a Roth TSP, you can withdraw a specific dollar amount from each account, all from one account, or have the withdrawal distributed pro rata from each account.
Spending money meant for retirement is a risky proposition and can come at a high cost. So, before you decide to raid your nest egg, consider the opportunity cost and how that can impact your retirement.
For example, if you take an age-based 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.
Since distributions from the traditional TSP are considered ordinary income, any time you withdraw money from the account, you’re responsible for paying taxes on the amount. The taxes owed will include federal and may consist of state income taxes depending on where you live. Thus, taking a withdrawal means you’ll no longer be kicking the tax can down the road and will no longer receive tax deferral benefits.
Moreover, to ensure Uncle Sam gets what he’s owed, the TSP will withhold a mandatory 20% from traditional TSP distributions. Though the withholding is just an estimate, you may owe more or less. However, if you’re due a refund, you’ll have to wait until the following year when you file your taxes.
Note: One way around the mandatory withholding is to have the amount you want to withdraw transferred directedly to an IRA. Once the funds are in your IRA, you can withdraw them and select the amount you wish to withhold or have nothing withheld. However, caution is needed here; if you don’t have any taxes withheld, you can be hit with a penalty, so make sure you consult your tax or financial advisor.
Consider A TSP Loan
A TSP loan can be a more efficient way to access emergency funds since the loan is not considered taxable income. This means that if you pay the loan back, you’ll avoid the tax bill.
Additionally, if you plan to return the money, then a loan provides a repayment plan, making it more likely that you’ll repay the funds.
You can learn more about the TSP loan here.
Although an age-based withdrawal is not subject to the early withdrawal penalty, there may be other costs, including opportunity costs, years of lost tax deferral, and taxes due.
Hence, a TSP loan can be a better alternative if quick cash is needed since it would help avoid the adverse tax implications.
Since the TSP will represent a significant portion of your retirement income, it’s vital that you explore all your options before withdrawing from the account.
Consult a fee-only Certified Financial Planner™ if you need help creating your financial plan.
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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.