Retirement accounts (TSP, IRA, 401k etc.) can be a great way to save money for retirement while also getting significant tax benefits.
But with these benefits comes a number of rules that limit when and how you can access these funds.
One of the most well known rules is the rule of 59 and ½. Basically, for many retirement accounts you will have to pay a 10% penalty if you access them before age 59 and ½.
But the good news is that there are many (completely legal) loopholes around this penalty within the TSP but you will want to be very careful to use them correctly because the cost for a mistake can be very high.
Age 55 and 50
The simplest rule to get around the 10% penalty before 59 and 1/2 is available to you if you retire in the year you turn age 55 or later. For example, if you turn 55 in December of this year and you retire this year as well then you’d be able to access your TSP without the 10% penalty.
But now let’s say you decide to retire one year earlier during the year you turn 54. In this case, you will be subject to the 10% penalty for any TSP distributions even after you turn 55. Basically, if you leave service before the year you turn 55 then you will have to wait until age 59 and ½ to avoid the 10% penalty (unless you qualify for a different exception).
Note: Your traditional TSP withdrawals will still be subject to taxes even if you avoid the 10% penalty.
Special Provisions
But yet again, the rules are a little different for those federal employees who are under special provisions like air traffic controllers and firefighters. For these groups they would be able to access their TSP without penalty if they leave service in the year they turn 50 or later.
IRA Mistakes
One very important thing to know is that IRAs do not waive the 10% penalty at age 55 or 50 like your TSP does. For example, let’s say you retire at age 56 and you qualify to avoid the 10% penalty on your TSP withdrawals. But if you decide to roll your TSP into an IRA then you won’t be able to access those IRA funds without penalty before 59 and ½ (unless you use SEPP, see below).
Because of this rule difference, some retirees wait to rollover their TSP until age 59 and ½ or they choose to rollover only the funds they won’t need until after 59 and ½.
SEPP or 72T
The last way to avoid the 10% penalty before 59 and ½ is by using what the IRS calls SEPP or substantially equal periodic payments. This strategy is also called a 72t withdrawal.
Basically if you take out a certain amount from your TSP or IRA every year for 5 years or until age 59 and ½ (whichever comes later) then you won’t have the 10% penalty.
The amount you’d withdraw is calculated one of three ways and you can choose which calculation to use. The three different methods are:
The amortization method
The minimum distribution (or the life expectancy method)
The annuitization method
The amortization method produces the highest withdrawal amount while the minimum distribution method generally produces the lowest.
Bankrate has a popular calculator to estimate what each of these methods might look like for you.
Note: As I mentioned before, you will want to be very sure that you understand this strategy before you try to use it. Mistakes can cause all of your withdrawals to be subject to the 10% penalty. I always recommend you talk to a tax pro before using SEPP.
Final Thoughts
Every year it seems that I talk to more and more people who are looking to retire early from federal service. And if you are one of those people then getting penalty-free access to your TSP can be a great way to bridge the gap between other income sources like your pension and Social Security.
