Thrift Savings Plan participants can avoid the 10 percent penalty for withdrawing money from their accounts before they’ve reached age 59½.

That’s good news for those of you interested in retiring before reaching that not-so-old age. And with all the talk about cutting federal retirement benefits, there seems to be more interest than ever in retiring sooner than later.

In my Aug. 8 column, I explained how the loss of an additional year or more of work will probably cost
most career feds more than some of the Civil Service Retirement System and Federal Employees
Retirement System benefits cuts being considered. Still, if you’re considering leaving at a relatively young age, you should understand your options for accessing your TSP account without triggering the early withdrawal penalty.

One of the simplest ways to avoid the penalty 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 will pay no early withdrawal penalty.

The annuity is irreversible, however, and may produce a stream of income significantly smaller than what could be produced through other 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. This option should only be selected after careful consideration and comparison with the alternatives.

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 is annual distributions that are certain to last your lifetime, but which may vary substantially in size from one year to another.

The annuity factor and amortization methods both rely on complex formulas that produce fixed annual distributions that may or may not 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. You must take exactly the
amount produced by an accepted calculation method each year, without adding any money to the
account, during the required period.

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.

There are several additional exemptions to the penalty for distributions taken from your TSP account
before you reach age 59½. These exemptions apply if the distribution is:

  • 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.
  • Made by an account owner who separated from federal service during or after the calendar year in which he reached age 55.

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.

The “age 55” exemption is not available for early distributions from an IRA, and this is a key difference between employer-sponsored plans like the TSP and individual retirement arrangements. Take this difference into account before deciding to roll over your TSP account to an IRA before you reach age 59½.

The rules governing early withdrawals from retirement plans are strict and can be complicated. You
should seek the guidance of a qualified accountant or financial planner before making any early
distribution decisions, since the effects of your decision will last a lifetime.

Written by Mike Miles
For the Federal Times
Publication September 12, 2011