We have already passed many age-related milestones thus far in life. Remember when you turned the age of 18 and were first able to vote? Remember when you reached the age that allowed you to drink legally (it varies by state)? How about your first “over the hill” party? I have to laugh because the first such party thrown for me was when I was 30. I’ve had several more “over the hill” parties and am hoping to avoid a “bottom of the hill” party for a long time.
This article will discuss another age-related milestone that some of you may have already passed, and that more of you have not. The milestone is the age of 59 ½. What are some of the things that hitting 59 ½ change?
You will be able to take penalty free withdrawals from traditional IRAs. Prior to age 59 ½, you would pay a 10% early withdrawal on top of the taxes due from the IRA unless you met one of the exceptions. Common exceptions are disability, medical expenses greater than 7.5% of your adjusted gross income, first-time home buyer, and substantially equal periodic payments (referred to by some as 72(t) payments) though there are a few more arcane ones.
What about the early withdrawal penalty on your TSP? You will likely be exempt from it at an age younger than 59 ½. If you retire from your federal job in the year you reach 55 (most employees) or 50 (special category employees), you are exempt from the early withdrawal penalty. However, if you retired before the year in which you reach those ages, you will be subject to the early withdrawal penalty all the way up until you reach 59 ½.
In your Roth IRA or Roth TSP, your withdrawals will become qualified at 59 ½ as long as you have had a Roth account for at least five years. If you withdraw from a Roth prior to age 59 ½, the part of the withdrawal that is due to earnings on your contributions will be subject to federal income tax because your earnings are not considered qualified until you hit 59 ½.
There is a difference between how withdrawals from Roth accounts are handled for an IRA or for your TSP. With your TSP, if you withdraw from your Roth balance, the withdrawal will be made proportionally between contributions and earnings; this will result in taxation of the part of the withdrawal due to earnings if you’re younger than 59 ½ – the contribution based withdrawal will be tax free.
In Roth IRAs, however, withdrawals are viewed as first coming from contributions, second from conversions, and, lastly, from earnings. So, if you withdraw no more than the amount attributable to your contributions and conversions, there will be no taxes due.
Even though there will be no tax due on withdrawals of conversions, there is a separate early withdrawal penalty if the converted money has not been in the Roth for five years. This five year period applies to each conversion you make. For example, the period for a conversion made in 2020 is January 1, 2025, for one made in 2022 it would be January 2027, and so on.
The good news is that, once you reach the magic age of 59 ½, you won’t have to worry about any of the above!
Retirement tidbit: A recent report issued by Charles Schwab noted that: “Retirement isn’t rally a switch you flip at a certain age anymore, it’s a financial state that allows for the flexibility to make work optional.”