Ask The Experts: Money Matters

By Mike Miles

TSP

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Q. I am a CSRS 50-year-old employee who would like to withdraw $80,000 from my TSP to cover unsecured debt. Is this smart? My debt is strangling me. What is the tax hit and how can I avoid it?

A. You don’t have the option to make a withdrawal unless you can demonstrate financial hardship under the TSP’s definition. If you take a Financial Hardship withdrawal, you will owe tax on the amount you take and you will be subject to the 10 percent early withdrawal penalty.

You can, and should consider taking a loan, instead. Taking a loan will avoid the tax and penalty. Loans are limited to $50,000 or 50 percent of your account balance, whichever is lower. You can learn more at www.tsp.gov under the topics “In Service Withdrawals” and “TSP Loans.”

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Mandatory retirement and TSP withdrawal

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Q: I am a firefighter about to be forced to retire at 57 years old because of the mandatory retirement age. I plan on taking out my Thrift Savings Plan earnings to buy my house when I retire. Do I still have to pay the 10 percent penalty for withdrawing from my TSP before turning 59 1/2 even though I was forced to retire because of my age?

A: Because you are retiring during or after the year in which you reach age 55, your subsequent TSP withdrawals will not be subject to the early withdrawal penalty.

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Early withdrawal from TSP

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Q: My position was eliminated when I was 51 years old. I retired with more than 30 years of service. I would like to withdraw all of my funds from the Thrift Savings Plan; will I be required to pay the 10 percent federal penalty if money is taken out prior to age 59 1/2?

A: Unless you meet one of the special exceptions to the early withdrawal penalty, you will have to pay it. For details, see the tax notice regarding distributions from your TSP account at the TSP website.

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TSP withdrawal for family need

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Q: I worked for the federal government for about 12 years. When I left, I used some of my Thrift Savings Plan money as a down payment on my current home. That turned out to be a good move, since I bought when the market was down and my home’s value has gone up. However, with the recent downturn in the market, my parents have lost a tremendous amount of money and are in financial need. I would like to give them the remaining money in my TSP account (about $10,000). Is there any way to roll over my TSP funds to my parents without taking a large financial hit? As I understand it, if I withdraw my funds to give to them, I would lose about half the money to penalties and taxes.

A: I’m not aware of any exception to the taxes and penalties that will apply based on the things you’ve mentioned. You should consult a tax adviser to be sure, however.

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TSP early withdrawal

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Q: The TSP website states that there is not a 10 percent penalty for early withdrawal if the withdrawal is made in a year that you have deductible medical expenses over 7.5 percent of your total income. If I made a withdrawal of $20,000 and my total income was $32,000, would there be no penalty at all? Seven and a half percent of $32,000 is $2,400. If my medical expenses were $4,400, would there not be a penalty, or would I have to pay a penalty on $18,000 {4,400-2,400 = 2,000}

A: As I understand the rules, the early withdrawal penalty will be waived to the extent that the withdrawn funds are used to pay qualified medical expenses that are in excess of 7.5 percent of your Adjusted Gross Income for the year. However, you should consult a tax adviser before proceeding.

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TSP withdrawals, taxes and loans

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Q: I turned 55 this year and just applied for disability retirement under the Federal Employees Retirement System. I have large bills I want to pay off. My income will drop the first year, then will decrease $1,000 the following year before continuing at that rate. I realize if I keep my Thrift Savings Plan or roll it over once I leave service, I will not be able too take a loan on it.

I realize I will need to pay my fair share of taxes, but is there a way I can work it out that I can take a loan on the money and pay it back over the next few years until I turn 62, thereby avoiding such a large amount of tax for this year (the income will put me in a higher tax bracket)? Also, could you explain how I could prevent a penalty if I should have to withdraw funds?

A: You’ll have to take withdrawals and pay the taxes, but because you’re separating from service during or after the year in which you reached age 55, you will not be subject to the early withdrawal penalty.

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One-time withdrawals

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Q: How much money can you take out for your one-time withdrawal without tax penalties? I am retiring under 6c, federal law enforcement retirement, at age 50.

A: Unless you meet one of the special exceptions to the early withdrawal penalty, the amount will depend upon your life expectancy and the calculation method you choose. This excerpt from my July 23, 2007, Money Matters column should help:

“Another exception to the early withdrawal penalty — one that is available to anyone — is to take distributions before reaching age 59 1/2 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 59 1/2, 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.

“[The Thrift Savings Plan'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 59 1/2 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 penalty.

“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 cases.

“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.”

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Early withdrawal penalty

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Q: I have checked your Q&A and have asked several people about the special retirement supplement (SRS) and can`t seem to get an answer. I’m a 56-year-old Postal Service employee with 22 years of service. Rumor has it there will be another VERA (early out). My two questions are, if I go out on VERA will I be able to take money out of my Thrift Savings Plan account without early withdrawal penalties even though I`m not 59 1/2 years old?  I know I will be eligible for SRS. Will the fact that I will be getting SRS, an annuity and TSP payments affect my estimated Social Security benefit at age 62?

A: You will not avoid the early withdrawal penalty rules unless you separate from service during or after the year in which you reach age 55.

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TSP withdrawals at age 55

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Q: I am currently in a Civil Service Retirement System 6C designated law enforcement officer position. Aside from my CSRS retirement benefits, of which I will reach the maximum annuity of 80 percent at the end of this year, I have also contributed to the Thrift Savings Plan. I am not planning on relying on my TSP funds to supplement my retirement.

I know there are ways to avoid the 10 percent tax penalty for early withdrawals before turning 55 years old (taking the money in a monthly annuity, etc.). I would like to take all of my TSP out and pay any taxes owed but avoid the penalty. The TSP booklet says as long as I retire “in the year I turn 55,” I am not subject to the penalty. So, if I retire in January (2011 is the year in which I turn 55) but do not actually turn 55 until September 2011, I am not subject to the 10 percent tax penalty. Am I interpreting this correctly?

A: There has been some debate over this issue. It is my understanding that you would not be subject to the early withdrawal penalty at any time during 2011, but you should consult a qualified tax adviser, someone who will actually prepare and defend your return, before proceeding.

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TSP and early retirement, redux

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Q: Your response to an earlier question on Voluntary Early Retirement Authority/Voluntary Separation Incentive Payments puzzles me. If a federal employee is eligible for a retirement annuity under the Federal Employees Retirement System despite the fact they are taking an VERA/VSIP, why would there be a penalty for “early” withdrawal of TSP?

A: I think that I clearly stated a fact (“There is nothing in your question that will exempt you from the early withdrawal penalty.”) that answers your question.

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