Many federal employees believe there is an early withdrawal penalty for taking anything out of the TSP before reaching age 59 ½, but this isn’t true. The rules for the early withdrawal penalty for the TSP are different from the rules for IRAs.
With the TSP, 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. For IRAs, the early withdrawal penalty will apply on anything you take out up until you reach the age of 59 ½.
Further, if you are a special category employee (SCE), you are exempt from the early withdrawal penalty if you separate in the year in which you turn 50 or later. (An SCE is a law enforcement officer, firefighter, air traffic controller, nuclear materials courier, Supreme Court or Capitol Police Officer, Customs and Border Protection Officer and DSS Special Agent with the Department of State.)
The early withdrawal penalty is a 10% penalty. In addition to any taxes you owe on your withdrawal, you will owe an additional 10%.
The ability to avoid the early withdrawal penalty if you separate in the year you turn 50 or 55 only applies if you leave your money in the TSP – rollovers are subject to the penalty. If you were to rollover your TSP into an IRA after separation before 59 ½, you would be subject to the early withdrawal penalty, regardless of whether you are a special category employee or not.
There are, however, ways to avoid the early withdrawal penalty if you retire prior to the year in which you turn the age of 50 or 55. If you follow a life-expectancy based withdrawal methodology for whichever is longer, 5 years or until you reach age 59 ½, you will be exempt from the penalty. If you were a regular employee and left at age 53, the longer period would be until age 59 ½. If you deviated from the life-expectancy based methodology, you would be subject to the penalty for anything you took out up to that time. The TSP has a withdrawal choice, substantially equal monthly payments based on the IRS life expectancy table that will meet the life-expectancy exemption from the penalty. You can also use a life expectancy based methodology to avoid early withdrawal penalties from IRAs.
Taxes can be complex and confusing. The TSP has a publication called Tax Information: Payments From Your TSP Account that will answer most questions you have about taxes. It includes a helpful table that tells how taxes are withheld from TSP disbursements. You will owe taxes at your rate for ordinary income, but the default withholding rate can vary significantly. You can find the above publication in the “forms and publications” section of the TSP website.
More background at ask.FEDweek.com: