Many hardworking federal employees set a financial and lifestyle goal of retiring at a young age — as early
as possible, in fact. More often than you might expect, it is a goal within reach. But retiring young can
cause some unpleasant side effects, not the least of which is paying early withdrawal penalties — a 10
percent federal tax — on certain Thrift Savings Plan distributions taken before you reach age 59½.

This tax can put a serious dent in your retirement lifestyle and may even make comfortable retirement
impossible. Fortunately, there are ways to avoid this penalty, but the rules are complex and strict, so
careful planning and execution are essential.

The first way around the early withdrawal penalty is through one of the “circumstantial” exemptions for
distributions that are:

  • Made because the account owner is totally and permanently disabled.
  • Ordered by a domestic relations court.
  • Made because of the death of the account owner.
  • Made during a year in which the account owner has deductible medical expenses exceeding 7.5 percent of adjusted gross income.

If you qualify for one of these exemptions, you will have unlimited access to your account after you
separate from service at any age, without penalty.

Another way to be exempt from the early withdrawal penalty: Separate from service during or after the
year in which you reach age 55. In this case, you may take as much money as you like before age 59½
without penalty, and it doesn’t matter if you go back to work outside the federal government after you

It is important to note that a similar exemption is not available for withdrawals from a traditional IRA. This
is a key difference between employer-sponsored plans and individual retirement arrangements, and it
should be carefully considered before deciding to roll your TSP balance into an IRA before reaching age

But what if you’d like to separate from service before the year you turn 55, would like to access your TSP
account before reaching age 59½, and don’t qualify for any of the circumstantial exemptions? You can
still make TSP withdrawals without penalty through a range of options based on your life expectancy.

The simplest withdrawal method is to use all or part of your balance to purchase a life annuity, either from
the TSP’s provider or from another insurance company that you choose. The annuity converts your
balance into a stream of income guaranteed to last at least as long as you live and on which you pay no
early withdrawal penalty. The downside is that the annuity is irreversible, inflexible and may produce a
stream of income significantly smaller than what could be produced through alternative withdrawal
methods. More important, it may produce a stream of income that fails to keep pace with inflation and
dramatically reduces your spending power through time.

Rather than purchasing an annuity from an insurance company, you can also avoid the early withdrawal
penalty by creating and managing your own annuity — taking withdrawals designed to distribute your
account balance over your lifetime. The IRS allows three alternative methods to be used in calculating the
penalty-free distribution — called substantially equal periodic payments — that can be taken from an
account each year: the life expectancy method, the annuity factor method or the amortization method.

The life expectancy method calculates each year’s distribution by dividing the previous year’s ending
balance by your remaining life expectancy, according to published tables. The result will be annual
distributions that are certain to last your lifetime, but which may vary substantially in size from one year to

The annuity factor and amortization methods both rely on complex formulas that produce fixed annual
distributions amounts that may or may not ultimately last for life. These two methods typically produce
similar distribution amounts that are significantly higher than that produced by the life expectancy method.

All of the substantially equal periodic payment exemptions require that the distributions continue,
undisturbed, for five years or until you reach age 59½, whichever is longer. This means that once the
distributions begin, they must continue and must not change, except as allowed, for at least five years.
You must take exactly the amount produced by an accepted calculation method each and every year,
without adding any money to the account, during the required period to avoid penalties. Violating the rules
will mean that penalty taxes and interest will be imposed on the entire stream of early distributions taken —
a strong incentive to stay within the rules.

You should probably seek the guidance of a qualified accountant or financial planner before making any
early distribution decisions, since the effects will last a lifetime.

Written by Mike Miles
For the Federal Times
Publication February 27, 2006