TSP Updates Financial Hardship Withdrawal Rules

Earlier in 2024, the Thrift Savings Plan updated its rules for in-service withdrawals. There are two types of TSP in-service withdrawals. They are: (1) Financial hardship withdrawals and (2) Age-based (age 59.5) withdrawals.

This is the first of two MFR discussing the updated TSP rules for TSP participants who make an in-service withdrawal and will present financial hardship withdrawals.

Consequences of Making a Financial Hardship Withdrawal

An in-service financial hardship withdrawal affects a TSP participant’s ability to accumulate savings and, in some cases, to defer taxes. This is because:

• When a TSP participant makes an in-service financial hardship withdrawal, the participant permanently reduces his or her TSP account by the amount withdrawn. The participant also gives up any future earnings on the amount withdrawn. Once withdrawn from a TSP account, the participant cannot return or repay the money to his or her TSP account. The amount withdrawn cannot be converted to a loan.

• The TSP participant must pay federal income taxes, and if the TSP participant lives in a state with a state income tax, state and local income tax on the taxable portion of the financial hardship withdrawal. If the TSP participant is younger than age 59.5, the TSP participant may have to pay a 10 percent early withdrawal penalty. Note that federal and state income taxes do not have to be paid on Roth TSP contributions that are included in a financial hardship withdrawal. However, the earnings on Roth TSP contributions are taxable unless they meet the IRS requirements for a qualified distribution.

What is a Financial Hardship TSP Withdrawal?

A financial hardship withdrawal is a withdrawal that a TSP participant makes while in federal service because of a genuine financial need. The TSP participant must pay income tax on the taxable portion of the financial hardship withdrawal, and a 10 percent early withdrawal penalty tax may be imposed.

Acceptable Reasons for Making a Financial Hardship Withdrawal

Acceptable reasons for making a financial hardship withdrawal include having negative cash flow and incurring extraordinary expenses. A worksheet in “MyAccount” on www.tsp.gov can help a TSP participant determine the amount of hardship withdrawal. These two acceptable reasons are discussed:

• Negative cash flow.

A TSP participant has negative cash flow if his or her net income is less than his or her expenses on a recurring basis. The worksheet in a TSP participant’s “MyAccount” will determine the amount of the negative cash flow. In order to get an accurate answer from the worksheet, the following information will be needed: (1) The TSP participant’s gross monthly income before taxes and other deductions, and a spouse’s gross monthly income; (2) Net monthly income equal to gross monthly income less monthly federal paycheck deductions such as federal and state income tax withholding, Social Security (FICA) and hospital insurance tax (Medicare Part A), and federal retirement deductions;(3) Total fixed monthly payments including rent or mortgage, real estate taxes, homeowner’s or renter’s insurance, monthly utilities, alimony or child support, and any installment loan payments other than a TSP loan, including credit cards or charge accounts. Interest charges are not included.

• Extraordinary expenses.

Extraordinary expenses that are not part of a TSP participant’s regular monthly cash flow which can contribute to a financial hardship. Only those expenses that have not been paid and will not be reimbursed including medical expenses, personal casualty expenses, legal expenses, and expenses and losses from a major disaster.

Eligible medical expenses are:

(1) Any medical expense that is not covered in part or in full by medical insurance, and therefore eligible to be deducted on one’s federal income tax return as a medical expense. The expenses must have been incurred by the TSP participant or a member of his or her family who can be claimed as a dependent for federal income tax purposes; and

(2) Expenses that have not been paid for household improvements needed because of a medical condition, illness, or injury to the TSP participant or an immediate family member.
Eligible personal casualty losses include damage, destruction or loss of property from an identifiable event that is sudden, unexpected or unusual. Examples include earthquakes, hurricanes, tornadoes, floods, storms, fires or similar events.

However, personal casualty losses do not include:

(a) Loss of deposits when a bank or other financial institution becomes insolvent or bankrupt;

(b) Losses to a business or income-producing property; and

(c) Damage from normal wear and tear such as damage or destruction caused by termites or moths or progressive deterioration of one’s property.

Eligible legal expenses are limited to unpaid legal fees and court costs related to a separation or divorce from the TSP participant’s spouse.
Expenses and losses resulting from a major disaster declared by the Federal Emergency Management Agency (FEMA). The TSP participant’s principal residence or principal place of employment at the time of the disaster must be located in the area designated by FEMA.

TSP Rules for Making a Financial Hardship Withdrawal

The following rules apply to making a TSP financial hardship withdrawal:

• A TSP participant cannot request less than $1,000.

• The TSP funds may be taken only from the TSP participant’s own contributions and the earnings on those contributions.

• No money can be withdrawn directly from money invested in the TSP’s “mutual fund window.” The TSP participant must first transfer any “mutual fund window” funds to the TSP core funds before withdrawing it.

• Those TSP participants who have both traditional and Roth TSP money available for a hardship withdrawal must specify the source of the withdrawal – traditional, Roth or taken from both funds pro-rata.

• A financial hardship TSP withdrawal is limited to the amount of the TSP participant’s financial need.

• A TSP participant who has made a financial hardship withdrawal cannot make another hardship withdrawal for a period of six months from the time the first hardship withdrawal payment is processed.

• A TSP participant may make a financial hardship withdrawal only from an account that is associated with the participant’s active employment. That means if a TSP participant owns a uniformed services TSP account, but the TSP participant has left the uniformed services and is an active federal employee, then the TSP participant can only make a financial hardship withdrawal from the active civilian TSP account.

How to Apply for a Financial Hardship Withdrawal

TSP participants who are ready to request a TSP hardship financial withdrawal should log onto “MyAccount” to begin the request.

TSP Hardship Financial Withdrawal Versus a TSP Loan

TSP participant who are in need of a financial hardship withdrawal and who are eligible for a TSP general purpose loan may want to give consideration to a TSP general purpose loan. This is because a TSP loan has certain advantages over a withdrawal. Among the advantages of a TSP loan: (1) A TSP loan is not taxable income, and (2) A TSP loan is repaid by the TSP participant and therefore the loan proceeds being paid back accrue earnings on the money the TSP participant borrowed after the loan proceeds are paid back.

The following chart compares how taking a TSP loan or making an in-service financial hardship withdrawal can affect a TSP participant’s account: