It is not an easy task for federal employees to withdraw money at a pre-retirement age from the traditional TSP or from a traditional IRA and not be subject to an IRS early withdrawal penalty. But in recent years penalty-free early withdrawals in fact have gotten easier.
This column discusses the exceptions that allow a federal employee to make withdrawals from their traditional TSP or from a traditional IRA before age 59.5 and not be subject to an early withdrawal penalty.
- TSP Withdrawals Fixed Payment Option
- TSP Withdrawal Payments Based on Life Expectancy
- Coordinating TSP Withdrawals and Receipt of Social Security Retirement Benefits
The first point is that retirement accounts are designed for post-working career and should not be tapped unless no other options are available.
The second point is that funds withdrawn from the traditional TSP, or the traditional IRA, are considered income and will be taxed, both by the IRS and by states which have state and local taxes.
Early Withdrawal Penalty Exceptions
The following are some early withdrawal penalty exceptions:
• Traditional IRA owners and traditional TSP participants are allowed to pay bills for financial emergencies.
This exemption is limited to one withdrawal per year and a maximum of $1,000 for “unforeseen or immediate financial needs” related to personal or family emergencies.
• Federal employees who have a total and permanent disability because of a mental condition.
In order to make an early withdrawal due to a mental condition, there is a “high bar” for a TSP participant or an IRA owner to achieve. The TSP participant/IRA owner cannot engage in any substantial gainful activity.
In other words, the TSP participant/IRA owner must be totally disabled. Note that with respect to the TSP, the TSP states in its publication “TSP Distributions and Taxes” that the TSP cannot certify to the IRS that a TSP participant who is in federal service and younger than age 59.5 and who requests payments due to total and permanent disability meets this exemption requirement when the participant’s federal income taxes are filed. The participant therefore must provide justification to the IRS when his or her federal income tax return is filed.
• Victims of domestic abuse.
Within the past 12 months, a TSP participant or a traditional IRA owner who is the victim of domestic abuse by a spouse or domestic partner can withdraw from their TSP or traditional IRA the lesser of $10,000 or 50 percent of their account balance.
The TSP cannot certify to the IRS that a TSP participant meets this exemption. The TSP participant must provide the justification to the IRS when the TSP participant’s federal income tax return is filed for the year in which the TSP distribution was made.
• Federal employees living in areas in which there has been declared a federal disaster area are eligible to withdraw up to $22,000 from their traditional IRAs without penalty.
This relief is for areas in the US that have experienced hurricanes, tornadoes, wildfires or floods.
• TSP participants and traditional IRA owners who are diagnosed with a terminal disease – defined in the law as an illness reasonable expected to result in death within seven years – are allowed to withdraw any amount from their TSP/IRAs penalty-free.
A TSP participant who made withdrawals due to being diagnosed with a terminal disease must provide the justification to the IRS when the participant files his or her federal income taxes for the year in which the TSP withdrawals were made.
• A TSP participant can request distributions from his or her traditional TSP account in a year in which the TSP participant has deductible medical expenses that exceed 7.5 percent of the participant’s adjusted gross income (AGI).
• Other IRA early withdrawal penalty exceptions include:
(1) Higher education expenses at an accredited institution for the IRA owner, the IRA owner’s spouse, the IRA owner’s children and grandchildren; and
(2) Up to $10,000 can be withdrawn and used to purchase an IRA owner’s first home.
• Other TSP early withdrawal penalty exceptions include:
(1) Traditional TSP withdrawals made by a TSP participant who separates from federal service during/after the year the participant reaches age 55;
(2) Traditional TSP withdrawals from federal public safety employees (as defined in Internal Revenue Code Section 82(t)(10)(B)), who separate from federal service during or after the year the employee reaches age 50 with 20 years of public safety service, or at any age with 25 years of public safety service;
(3) Up to $5,000 of a traditional TSP distribution received within one year following a birth or qualified adoption of a child in accordance with Internal Revenue Code Section 72(t)(2)(H);
(4) TSP annuity payments; and
(5) Traditional distributions resulting from death and payments made from a TSP beneficiary account.
IRS Form 5329 (Additional Taxes on Qualified Retirement Plan Including IRAs and Other Tax-Favored Plans) is used to report the additional taxes on one’s federal income tax return for the year in which an early (pre-age 59.5) distribution was made.
Exceptions to the Additional Tax on Early Distributions
In the instructions to IRS Form 5329, the following reasons are listed as exceptions to the additional taxes:
01 Qualified retirement plan distributions (doesn’t apply to IRAs) you receive after separation from service when the separation from service occurs in or after the year you reach age 55 (age 50 for qualified public safety employees). For distributions to qualified public safety employees on or after December 30, 2022, include distributions to employees with 25 years of service with the plan, distributions to firefighters covered by private sector retirement plans, and distributions to those employees who provide services as a corrections officer or as a forensic security employee, providing for the care, custody, and control of forensic patients, who meet the age requirement above.
02 Distributions made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from an employer plan, payments must begin after separation from service). Distributions received as periodic payments on or after December 29, 2022, will not fail to be treated as substantially equal merely because they are received as an annuity.
03 Distributions due to total and permanent disability. You are considered disabled if you can furnish proof that you can’t do any substantial gainful activity because of your physical or mental condition. A medical determination that your condition can be expected to result in death or to be of long, continued, and indefinite duration must be made.
04 Distributions due to death (doesn’t apply to modified endowment contracts).
05 Qualified retirement plan distributions up to the amount you paid for unreimbursed medical expenses during the year minus 7.5% of your adjusted gross income (AGI) for the year.
06 Qualified retirement plan distributions made to an alternate payee under a qualified domestic relations order (doesn’t apply to IRAs).
07 IRA distributions made to certain unemployed individuals for health insurance premiums.
08 IRA distributions made for qualified higher education expenses.
09 IRA distributions made for the purchase of a first home, up to $10,000.
10 Qualified retirement plan distributions made due to an IRS levy.
11 Qualified distributions to reservists while serving on active duty for at least 180 days.
12 Distributions incorrectly indicated as early distributions by code 1, J, or S in box 7 of Form 1099-R. Include on line 2 the amount you received when you were age 59½ or older.
13 Distributions from a section 457 plan, which aren’t from a rollover from a qualified retirement plan.
14 Distributions from a plan maintained by an employer if:
You separated from service by March 1, 1986;
As of March 1, 1986, your entire interest was in pay status under a written election that provides a specific schedule for the distribution of your entire interest; and
The distribution is actually being made under the written election.
15 Distributions that are dividends paid with respect to stock described in section 404(k).
16 Distributions from annuity contracts to the extent that the distributions are allocable to the investment in the contract before August 14, 1982. For additional exceptions that apply to annuities, see Tax on Early Distributions under Special Additional Taxes in Pub. 575.
17 Distributions that are phased retirement annuity payments made to federal employees. See Pub. 721 for more information on the phased retirement program.
18 Permissible withdrawals under section 414(w).
19 Qualified birth or adoption distributions. Attach a statement that provides the name, age, and TIN of the child or eligible adoptee.
20 Distributions due to terminal illness made on or after December 30, 2022. Distributions that are made after the date on which your physician has certified that you have an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.
21 Corrective distributions made on or after December 29, 2022, the income on excess contributions distributed before the due date of the tax return (including extensions).