While the TSP is great at providing tax benefits and allowing federal employees to save for retirement efficiently, it has several restrictions that limit how and when savings can be accessed.
In fact, most federal employees are aware of the age restriction that imposes a penalty on TSP withdrawals before age 59 ½; however, many are unaware of the exceptions to this rule.
In a previous article, we covered the Substantially Equal Periodic Payments (SEPP) option, which federal employees can use to access their TSP early; this week, we’re covering another means to withdraw from the TSP before age 59 ½.
The General Rule
One of the most well-known TSP rules is the age 59 ½ rule, which imposes a 10 percent penalty if you withdraw from your TSP before, you guessed it, age 59 ½. Actually, this isn’t a TSP rule but one that the IRS imposes on most retirement or tax-advantaged accounts, including 401(k)s, 403(b)s, IRAs, and some insurance products.
Although none of us like restrictions on our savings, the good news is that there are several exceptions to this rule that will allow Feds to withdraw from their TSP before age 59 ½ and avoid the early withdrawal penalty.
An important point to remember is that while exceptions allow federal employees to avoid the 10 percent penalty, they’ll still owe federal income taxes (and likely state income taxes) on withdrawals from tax-deferred accounts (e.g., traditional TSP).
So, how does this exception work? Well, if a federal employee separates from federal service, whether retired or resigned, in the year they turn age 55 or older, they can withdraw from their TSP penalty-free. This is the wording the IRS uses:
“Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental benefit plan, as defined in section 414(d) if you were a qualified public safety employee (federal state or local government) who separated from service in or after the year you reached age 50.”
What’s this about public safety employees? In FERS lingo, we often refer to them as Special Category Employees or Special Provision Employees; they’re covered next.
Special Category Employees
Most federal employees enjoy the same robust benefits; however, special category employees, namely law enforcement officers, firefighters, and air traffic controllers, are eligible for enhanced retirement benefits and are governed by different retirement rules.
This means that if you’re a special category employee and separate from service in the year you turn 50 or older, you can access your TSP penalty-free.
Word of Caution
While having several methods for accessing your TSP before age 59 ½ is great, caution must be taken to ensure you don’t make a mistake and become subject to the early withdrawal penalty.
For instance, an important point to keep in mind is that, unlike the TSP, IRAs do not waive the 10% penalty at age 55 or 50
So, let’s say a federal employee retires at age 57 and qualifies to avoid the 10% penalty on their TSP withdrawals. If they decided to transfer their TSP to an IRA, they would inadvertently subject their funds to IRA rules which do not include the age 55 (or 50) exception. Thus, they would lose their ability to take penalty-free withdrawals.
Because of this rule difference, many federal retirees wait until age 59 ½ to transfer their TSP to an IRA. Read this article to learn more about the differences between the TSP and IRA.
With many federal employees retiring early, utilizing this exception can be an excellent method for tapping into their TSP and bridging the gap between other income sources like the FERS pension and Social Security.
However, federal employees retiring early must ensure they don’t deplete their retirement savings too soon since many will need to fund a 35–45-year retirement. Additionally, remembering that the rules governing TSPs, and IRAs differ can help many avoid inadvertently subjecting themselves to the early withdrawal penalty.
This is why I strongly encourage every federal employee to have a retirement income plan before pulling the trigger on retirement. If you don’t feel confident creating your retirement income plan, consult a fee-only Certified 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.