There is still a lot of confusion about the 10% early withdrawal penalty and whom it applies to. The source of that confusion is Congress – well, at least laws that Congress has passed.
The early withdrawal penalty is a 10% penalty. In addition to any taxes you owe on your withdrawal, you will owe an additional 10%. In general, for TSP account holders, you are exempt from the early withdrawal penalty if you separate from federal service in the year in which you reach age 55 or later (age 50 for special categories); not so for IRA accounts.
A lot of the confusion results from the fact that there are two major types of retirement plans. First was the Individual Retirement Arrangement, or IRA. Then came employer sponsored defined contribution plans like the Thrift Savings Plan. They are similar, but they are not the same, and that’s where the confusion comes in.
When the IRA was introduced in 1974, it was designed as a retirement savings tool. Contributions were to be made with pre-tax dollars and earnings were to grow tax deferred so that an account holder could accumulate money for their anticipated retirement. There were changes to IRAs as time passed and, today, the type of IRA that was introduced back in 74 is referred to as a “traditional deductible IRA” To encourage that the money be saved for retirement, penalties were put in place for those who withdrew money too early or waited too late to begin their distributions. Of course, the law had to define what “too early” and “too late” meant. Congress chose the age of 59 ½ to be the dividing line between too early and just right for IRAs.
Employer sponsored plans like the TSP were patterned after this first IRA, except that the laws that created these employer plans were different in several ways from the earlier laws that created IRAs. One of the major differences between the plans was the definition of “too early”. For employer sponsored retirement plans, Congress chose the age of 55 as the dividing line, rather than 59 ½. Congress added a little more confusion in 2016 when a change was made so that special category federal employees (i.e., 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) had a dividing line of 50, rather than 55 for penalty free withdrawals from their TSP accounts.
So – when will an individual be affected by the 10% early withdrawal penalty? It depends on what kind of retirement account we are talking about. In an IRA, the early withdrawal penalty will apply to any money you withdraw up until the day you reach the age of 59 ½. This is true even if the money you are withdrawing from the IRA was rolled over from an employer sponsored retirement plan. Be aware this if you are thinking of rolling your TSP account over to an IRA and plan on taking withdrawals from that IRA prior to reaching 59 ½.
If you leave your money in the TSP (or another employer sponsored retirement account), you will not be subject to the early withdrawal penalty if you separated from your job in the year in which you reached the age of 55 or later. Note that for employer sponsored accounts, it is the year in which you reach the age, not the date you reach it as it is with an IRA. For special category employees, that age is 50, not 55.
Some employees choose to separate from their federal employment prior to the year in which they reach the age of 55 or 50 (for special category employees). They can avoid the early withdrawal penalty if they follow a life expectancy based withdrawal methodology for the longer of five years or until they reach the age of 59 ½.
Do not assume that all retirement plans are identical. Know the differences before you begin your withdrawals.