TSP

Early withdrawal penalties have been attached to tax-advantaged retirement accounts since the introduction of the Individual Retirement Arrangement (IRA) in 1974, and these penalties are different for different classes of retirement accounts. As often is the case, IRAs and employer sponsored accounts (such as the Thrift Savings Plan) have slightly different rules. Let’s look at the rules for the early withdrawal penalty on the TSP first, and then we’ll look at how they are handled for IRAs.

A 10% early withdrawal penalty will apply to withdrawals from your TSP (traditional or Roth) if you separate from your federal job before the year in which you turn 55. If you were to separate before your 55th year of birth (see exception in next paragraph), you could avoid the penalty if you elected monthly payments based on the IRS life expectancy table and continue those payments for five years, or until you turn age 59 ½ whichever is longer; or you purchased a TSP annuity. Of course, you could simply wait until you turn 59 ½ to begin withdrawals and face no penalty.

There is a specific exception to the age 55 rule (above paragraph) for special category employees. Special category employees are defined as Law Enforcement Officers, Firefighters, Customs and Border Protection Officers, Air Traffic Controllers, Supreme Court and Capitol police officers, nuclear materials couriers and DSS Special Agents in the State Department. These folks are exempt from the early withdrawal penalty if they separate from service in the year in which they turn 50, or later. If they retire prior to the year in which they turn the age of 50, they can avoid the penalty as discussed in the paragraph above.

There are additional exceptions to the early withdrawal penalty if TSP distributions are:

1) Made because you are totally and permanently disabled;

2) Ordered by a domestic relations court;

3) Made because of the death of the account holder (beneficiary participant accounts only); or

4) Made during a year in which you have deductible medical expenses exceeding 7.5% of your adjusted gross income.

For IRAs, the early withdrawal penalty will apply up until you are age 59 ½, though what is subject to the penalty varies depending on the type of IRA.

For a traditional IRA where you were able to deduct your contributions from your federal income tax (traditional deductible IRA), everything you withdraw prior to age 59 ½ is subject to the 10% early withdrawal penalty.

For a traditional IRA where you were not able to deduct your contributions from your federal income tax (traditional non-deductible IRA), the early withdrawal penalty applies only to earnings withdrawn before 59 ½. Contributions came from already taxed money and are not subject to the penalty. You are viewed as withdrawing contributions and earnings proportionally from a traditional non-deductible IRA.

More on TSP Withdrawals at ask.FEDweek.com

For a Roth IRA, the early withdrawal penalty applies only to earnings withdrawn before 59 ½. It does not apply to either contributions or conversions, as they came from already taxed money and are not subject to the penalty. When you withdraw from a Roth IRA, you are viewed as first withdrawing from contributions; then from conversions; and only lastly from earnings, so it is possible to withdraw money from a Roth IRA before 59 ½ and not incur the early withdrawal penalty.

There are exceptions to the early withdrawal penalty for IRAs too. Similar to the TSP you could avoid the penalty if you followed a life expectancy based withdrawal methodology (including purchasing an annuity) for the longer of five years, or until you turn age 59 ½ Other exceptions are if the money withdrawn was used to pay for: 1) Unpaid medical expenses that are not covered by health insurance and that exceed 10% of your adjusted gross income; 2) College costs; and 3) Purchase of a first home (up to $10,000 single filing status and $20,000 joint filing status).

For IRAs there is also an exception to the penalty if you are totally and permanently disabled. A couple other arcane exceptions can be found in IRS Publication 590B, Distributions from Individual Retirement Arrangements.

Tax avoidance is perfectly legal; it’s tax evasion that’ll get you into trouble. Be aware of the how the 10% early withdrawal penalty works and do what you can to avoid it.