For most federal and military employees, the Thrift Savings Plan offers comparable benefits to private-sector individual retirement accounts and 401(k) plans. However, the options for penalty-free early withdrawals are not as generous as with other retirement plans. The TSP allows you to withdraw your money early, but if it's going for college tuition you'll get stuck with a 10 percent penalty as well as any taxes owed on the distribution. You may find other options more advantageous.
An early withdrawal is defined as any distribution from your TSP before you reach retirement age: 59 ½ for federal employees, or 55 for uniformed service. Such withdrawals are subject to applicable taxes and a 10 percent penalty, unless the amount is for an annuity, death benefit, divorce settlement, qualified medical expenses or if you become totally and permanently disabled. You cannot replace such withdrawals so you suffer a permanent reduction in the amount of savings. You can't make up the difference by contributing more later, due to restrictions on the amount of annual contributions.
Rather than take a withdrawal and penalty, consider whether a TSP loan is a better way to go. You won't earn any returns on the borrowed amount, but you can repay it, so you won't adversely affect your total retirement savings. You may only borrow up to the amount of contributions plus their earnings; you cannot borrow against matching funds. You can borrow for any purpose, including education, for up to five years, and up to 15 years to purchase a home. You'll have to start repaying within 60 days of disbursement, unlike regular student loans, which are deferred while you're in school. It's still a better deal than taking an in-service withdrawal.
Rollover to an IRA
If you are eligible for a traditional or Roth IRA, consider rolling over your TSP into one of these accounts. Both types of IRA allow early withdrawals for qualified education expenses without assessing the 10 percent additional penalty. You'll still owe any tax due on the distributions. If you have a pre-tax TSP and choose to roll over an amount into a Roth IRA, you will be subject to tax on the amount rolled over, otherwise it's a tax-free transaction.
Any early distribution from your TSP requires a 20 percent withholding for federal taxes. You may get this amount back when you file your tax return, but it does mean you won't be able to put the full benefit of the distribution toward your educational expenses until much later. The 10 percent penalty is assessed when you file your tax return. Depending on your age and field of study, you may find the negative aspects of an early TSP withdrawal are far outweighed by the potential for increased earning power with a college degree, allowing you to more than make up both the reduction in TSP account balance and associated additional tax liability.
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