Roth and Traditional TSP Early Withdrawal Penalty

The Internal Revenue Code imposes penalties in specific instances, one of which is a 10% penalty for early withdrawals from a retirement account. What is too early? It all depends. In the following sections, we’ll look at what age you have to be to avoid this penalty.

The penalty was initially imposed in 1974 when Individual Retirement Arrangements (IRAs) were implemented. Those who pulled money from their IRA at age 59 1/2 or older were exempt from the penalty; those who drew money before age 59 1/2 had to pay the penalty and taxes on the funds withdrawn. The penalty’s age of 59 1/2 refers to the particular day you become 59 1/2. Until 1987, all money in an IRA was pre-tax—it was contributed with pre-tax funds and grew tax-deferred.

When the Roth IRA was launched in 1997, any earnings (i.e., money that had not yet been taxed) taken before 59 1/2 were subject to an early withdrawal penalty. There’s no early withdrawal penalty for contributions or conversions (money that has already been taxed) withdrawn before that age. Withdrawals from Roth IRAs are viewed as arriving first from contributions, then from conversions, and finally from earnings. That’s not true in the Roth TSP (explained below); withdrawals in the Roth TSP are proportionate to contributions and earnings.

The TSP was established in 1987 and, like a traditional IRA, permitted pre-tax contributions and tax-deferred earnings. It also carried a 10% early withdrawal penalty; however it didn’t always apply up to 59 1/2. You were excluded from the penalty if you retired from your government position in the year you reached 55 (or later). It’s important to note that you received this exemption from the penalty in the year you turned 55, not on the day you turned 55. If you separated in a year before the year in which you became 55, the 10% penalty would apply until (the date) you turned 59 1/2. If you’re a special category employee (such as a police officer or a firefighter), you are exempt from the penalty the year you reach 50. That also applies to withdrawals from a Roth TSP.

But expect to pay taxes on Roth TSP withdrawals if you retire between the ages of 55 (or 50) and 59 1/2. A Roth TSP account has two parts: your contributions and the profits on those contributions. You paid taxes on your contributions, but the portion of the profit is only tax-free if you withdraw five years or more after creating the Roth and are at least 59 1/2 years old. Watch out for the “Roth Tax Trap!” Suppose you have both traditional and Roth balances in your TSP, separate before age 59 1/2 and start withdrawing from your TSP. In that case, your withdrawal will be considered proportionally from your traditional and Roth balances. You’ll have to pay taxes on the portion of your withdrawal from your Roth earnings portion until you turn 59 1/2. You may choose which part of your TSP to withdraw from (traditional or Roth); if you’re drawing from your TSP before age 59 1/2, it’s best to take from only the traditional component of your TSP.