I field many questions from readers who are confused about how IRS’ early withdrawal penalty applies to
withdrawals from the Thrift Savings Plan. Much of that confusion is because of exceptions to the rule.
Basically, the early withdrawal penalty is applied to distributions taken from certain tax-deferred retirement
accounts — like the TSP, 401(k), 403(b), traditional IRA and Keogh accounts — before the account
owner reaches age 59½. In the case of TSP accounts and traditional IRAs, the penalty does not apply to
any distribution taken after the account owner reaches age 59½. With some other accounts, there may be
instances in which the penalty will apply to withdrawals taken after age 59½, so care is needed to make
sure the penalty is avoided.
The early withdrawal penalty would be easy to understand and apply if it weren’t for the various
exceptions to the rules.
One of these exceptions is available because of TSP’s status as an employer-sponsored retirement plan.
This exception allows for penalty-free distributions to any account owner who separates from service
during or after the calendar year in which he or she reaches age 55. If you meet this requirement, you will
have access to your vested TSP balance, without penalty, from the date of separation onward. It doesn’t
matter how much service you have or what retirement system you’re under. This exception is also
available to separated participants in similar private-sector plans. It is not available for distributions from
Another exception to the early withdrawal penalty — one that is available to anyone — is to take
distributions before reaching age 59½ as a series of so-called substantially equal periodic payments
(SEPP). By agreeing to begin converting your account balance to a stream of income designed to last for
life, you avoid the penalty. There are three methods of computing the amount of each distribution,
including one that produces a varying stream of annual income and two that produce fixed streams. What
they all have in common is the distributions must continue uninterrupted for at least five years or until you
reach 59½, whichever period is longer. The SEPP exception requires only that the exact amount of the
computed withdrawal be taken by Dec. 31 each year, so the number and timing of the distributions during
each year are up to you.
TSP’s withdrawal limitations will require a monthly payment schedule, but the SEPP exception applies to
IRA distributions, so you could roll your TSP balance over to an IRA to gain more withdrawal flexibility.
While your SEPP plan must be designed to provide income over a lifetime, it doesn’t actually have to do
so. Once you’re 59½ and the payments have continued for at least five years, you may terminate the
payments and begin withdrawing money according to your needs, without penalty.
An important fact to remember when considering using a SEPP series to extract money from your
account without penalty: The calculations and rules that govern this exception are complex, and the
penalty for mistakes can be high. So make sure that you, or someone you trust to guide you, have a
thorough understanding of the requirements before proceeding down this path.
One of the attractive aspects of the SEPP exception is that it allows you to retain ownership and control of
your savings, while providing penalty-free income before age 59½. Alternately, you can avoid the penalty
by using part or all of your TSP balance to purchase an immediate life annuity after separating from
service. This produces a regular stream on income that is guaranteed to last, at least, for life, but in
exchange, you forfeit ownership and control of the principal used to purchase the annuity. I wouldn’t
suggest using an annuity only to avoid the early withdrawal penalty for a few years, but if it’s something
you would consider anyway, it’s useful to know that it can begin at any age without being subject to the
Other exceptions to the early withdrawal penalty are available for total and permanent disability, death,
certain court-ordered payments and qualifying medical expenses. These exceptions are based on
circumstances that are largely outside the control of the plan participant and available only in a minority of
You can learn more about all of the exceptions to the early withdrawal penalty by reading IRS Publication 590, at www.irs.gov; and TSP Tax Notices, under “Publications” at www.tsp.gov.
Written by Mike Miles
For the Federal Times
Publication July 23, 2007