By Hank Coleman
Posted in Savings Account
Members of the military and federal government employees who participate in the Thrift Savings Plan (TSP) can withdraw money during a financial emergency. This feature is called an in-service withdraw or TSP hardship withdraw. While it may be a good safety valve for investors, it is an plan option that should only be used in a dire financial emergency.
To qualify for an in-service TSP hardship withdraw, you must meet certain criteria. You must have a recurring negative monthly cash flow, medical expenses not paid or covered by insurance, personal casualty losses not covered by insurance, or legal expenses stemming from a separation or divorce from your spouse. Although you will not have to prove your financial hardship to the Thrift Savings Plan board, you will be asked to disclose the reason on your TSP withdraw request form. And you could have to prove a genuine financial hardship and the reason for the TSP withdrawal should you get audited by the IRS.
You should consider a TSP hardship withdraw only when you have exhausted all other options. The loss that you will receive from taxes, early withdraw penalty, and future loss of compounding interest may not make the hardship withdraw any more economically feasible. There may be other options to solving your financial hardships than by taking out an early TSP withdraw from your retirement account. While not the best option either, you could also consider a Thrift Savings Plan loan where you would borrow money from your retirement account without penalty and repay the money back to yourself with interest.
When you have a Thrift Savings Plan withdraw, it is money that is forever lost from your account. That TSP withdraw will never earn interest for you. If the withdraw happened early in your career, you would lose the power of that money compounding year after year. Also, if you were maximizing the contributions that you made into TSP with the yearly $16,500 contribution limit, you will not be allowed to make a catch up contribution should you have a windfall situation or find additional money to replace the money lost from your account because of a hardship withdraw. Your future TSP contributions will also be suspended for six months following a hardship withdraw which is a long time to forgo compound earnings on your retirement savings. Because the Thrift Savings Plan is funded with before-tax dollars, you will owe ordinary income taxes on any distributions you receive. If you are younger than 59 ½ years-old, you will also be required to pay a 10% penalty.
A TSP hardship withdraw is a feature that a good fallback position if you are hit with a severe financial hardship. But, it is a feature of the Thrift Savings Plan that should only be used as a last resort. The future implications to your retirement account and its loss of compounding interest could be devastating to your nest egg decades later when you may need it.
Hank Coleman is a Captain in the U.S. Army, freelance writer, and the founder of personal finance sites such as Military Money Might. His writing has been featured on The Motley Fool, Military.com, and many others. You can follow him on Twitter at @HankColeman.