What Happens to Your TSP and FEHB When You Retire Before the Standard Age?

Key Takeaways:

1. Retiring before the standard age significantly impacts your Thrift Savings Plan (TSP) and Federal Employees Health Benefits (FEHB), but understanding the rules ensures better planning.

2. Accessing benefits early may lead to penalties, reduced payouts, or additional costs, but strategies like age-based withdrawals and maintaining eligibility can mitigate these effects.

Retiring Before the Standard Age: What’s at Stake?

Federal employees often plan their careers around specific retirement milestones. But what happens if you choose to retire earlier than expected? Your TSP and FEHB benefits are at the center of your financial and health security in retirement, and early retirement could impact them significantly. Knowing how these programs function before, during, and after retirement is crucial for making informed decisions.

Your Thrift Savings Plan (TSP): Early Retirement Considerations

The TSP is one of the cornerstones of federal employee retirement planning. Retiring before the standard age introduces complexities to how you access and manage these savings.

Age Penalties for Early Withdrawals

If you retire before reaching 59½, withdrawals from your TSP are subject to a 10% early withdrawal penalty. However, there are exceptions to this rule:

• Age 55 Rule: If you retire in the year you turn 55 or older (50 for certain public safety employees), you can take penalty-free withdrawals from your TSP.

• Substantially Equal Periodic Payments (SEPP): This strategy allows penalty-free withdrawals before 59½, provided you follow IRS rules. However, it requires a commitment to a rigid withdrawal schedule.

Tax Implications

Withdrawals from your TSP are taxed as ordinary income unless you’ve contributed to a Roth TSP. Roth withdrawals are tax-free if you meet the age and holding period requirements.

Leaving Your Money in the TSP

Even if you retire early, you’re not required to start withdrawing funds immediately. Keeping your money in the TSP allows it to grow tax-deferred, giving you flexibility to plan withdrawals strategically.

Maximizing Your FEHB Benefits Before Medicare

The FEHB program provides robust health coverage, but retiring early means carefully navigating how you maintain this coverage until Medicare kicks in at age 65.

Continuing FEHB into Retirement

To carry your FEHB coverage into retirement, you must meet these two conditions:

1. Five-Year Rule: You must have been enrolled in FEHB for the five years immediately before retirement.

2. Retirement Eligibility: You must retire under conditions that allow you to retain benefits, such as meeting Minimum Retirement Age (MRA) + 10 rules.

Cost Considerations

While your FEHB premiums remain the same in retirement, you’ll now pay both the employee and government share. This can significantly increase your out-of-pocket costs if you’re not prepared.

Bridging the Medicare Gap

If you retire before age 65, FEHB acts as your primary coverage until you’re eligible for Medicare. Understanding how to coordinate benefits once you reach Medicare eligibility ensures seamless health coverage and minimizes costs.

The Role of Minimum Retirement Age (MRA)

The Minimum Retirement Age under FERS varies depending on your birth year, ranging from 55 to 57. Retiring before your MRA can limit access to certain benefits, including your pension and the FERS Special Retirement Supplement (SRS).

MRA + 10 Retirement

If you have at least 10 years of service but retire before your MRA, you can still qualify for a reduced pension. However, your annuity will be reduced by 5% for each year you’re under age 62.

Special Retirement Supplement (SRS)

This supplement, designed to bridge the gap between retirement and Social Security eligibility, is unavailable if you retire before your MRA. Retiring early means losing out on this additional income stream.

Early Retirement Scenarios: Navigating Key Challenges

Health Insurance Coverage Gaps

Retiring early could leave you without affordable health insurance if you don’t meet FEHB eligibility requirements. COBRA coverage is an option, but it’s costly and only temporary. Planning to meet the FEHB five-year rule ensures continuous coverage.

Lower Pension Payments

An early retirement typically means fewer years of service and lower “High-3” average salary, resulting in a smaller pension. Understanding how these factors interact helps you project your financial needs accurately.

Accessing Savings Strategically

To avoid penalties and optimize withdrawals, consider using a mix of TSP funds, taxable savings, and other retirement accounts to bridge the gap between early retirement and eligibility for penalty-free withdrawals or Social Security.

Bridging the Financial Gap Before Standard Retirement Age

Maximizing TSP Contributions Before Retirement

To prepare for early retirement, aim to contribute the maximum to your TSP. For 2025, the TSP contribution limit is $23,500, with an additional $7,500 catch-up contribution for those aged 50 and older.

Creating a Withdrawal Strategy

• Use the Age 55 Rule or SEPP to minimize penalties.

• Withdraw from taxable accounts first to allow tax-advantaged accounts to continue growing.

• Consider a mix of traditional and Roth TSP contributions to provide tax diversification.

Supplementing Income with Other Savings

If you’ve saved in an IRA or taxable brokerage account, these funds can provide early retirement income without tapping your TSP prematurely.

Preparing for the Transition

Understanding Your FEHB Options

• Review plan offerings annually to ensure your coverage meets your needs.

• Factor in the cost of premiums without employer contributions when planning your budget.

Estimating Healthcare Costs

Healthcare is a major expense for early retirees. Consider:

• Premiums for FEHB coverage.

• Out-of-pocket costs for medical services and prescriptions.

• Long-term care insurance, which becomes more expensive with age.

Evaluating Your Pension

Request an estimate of your annuity from your agency’s HR office. Use this information to:

• Determine the impact of early retirement on your pension.

• Plan for other income sources to supplement reduced annuity payments.

Strategies for a Smooth Transition

Use Phased Retirement

Phased retirement allows you to work part-time while collecting a portion of your annuity. This option helps ease the financial and lifestyle shift to full retirement.

Consider a Post-Retirement Job

Many federal retirees find part-time or consulting work to supplement their income and stay engaged professionally. This can also delay tapping into retirement savings, allowing them to grow.

Health Savings Accounts (HSAs)

If you’re enrolled in a high-deductible health plan, contributing to an HSA before retirement offers tax-advantaged funds for future medical expenses.

Planning Early Leads to Peace of Mind

Retiring before the standard age is a significant decision that requires careful planning. By understanding the implications for your TSP and FEHB, you can make informed choices to protect your financial and healthcare security. Whether it’s meeting eligibility rules, managing healthcare costs, or strategically accessing savings, preparation ensures your early retirement dreams remain achievable.

Charting Your Course with Confidence

Retiring early doesn’t mean compromising your financial future. By leveraging strategies to optimize your TSP, maintain FEHB coverage, and supplement your income, you can confidently transition into this exciting new chapter. Always evaluate your options carefully, consult with a financial advisor, and stay proactive in managing your benefits to ensure a smooth and secure retirement.