Ideally, parents started contributing to a 529 plan or another type of college savings account when their kids were still little. However, this may not be possible for many federal workers just starting their careers and raising a family. When the time comes to send the kids off to college, there may be the temptation to withdraw funds from your Thrift Savings Plan (TSP) to avoid a student loan. Before you decide consider the drawbacks.
10% Early Withdrawal Penalty If You’re Younger Than Age 59.5
When you withdraw from your TSP before the age of 59.5, you’ll likely be subject to a 10% penalty under IRS rules. Although the TSP allows early, penalty-free withdrawals under the “Hardship Withdrawal” provision, these are usually reserved for extreme financial needs such as avoiding foreclosure on your home. College tuition doesn’t qualify as a hardship under TSP rules.
Withdrawals From The Traditional TSP Are 100% Taxable
When you withdraw funds from a tax-advantaged retirement plan like the traditional TSP or a 401(k), it’s considered taxable income. If the amount is significant, it may bump you into a higher tax bracket in the year you take the distribution. This means you may have to withdraw even more to cover the taxes you’ll owe Uncle Sam. And, depending on where you live, your TSP withdrawal may be subject to state income taxes, too.
“With a TSP loan, you’re not taxed on the loan amount, and the money you borrow is deposited back into your account, with interest, as you repay the loan.”
TSP Withdrawals Before Retirement Result In A Loss Of Growth
Thanks to compound interest, your TSP account has the potential for significant growth over time. When you withdraw a large amount before retirement, the loss of growth on your principal can potentially put your retirement at risk. Financing your child’s college education to keep them from dealing with the burden of student debt is a noble goal. However, the loss of retirement savings may put you in the position of needing financial help in the future.
Consider Taking Out A TSP Loan
There are advantages to taking out a TSP loan to cover college tuition instead of making a TSP withdrawal. A withdrawal is taxed as income and permanently reduces your TSP balance. If you’re younger than 59.5 you’ll also owe a 10% penalty. With a TSP loan, you’re not taxed on the loan amount and the money you borrow is deposited back into your account, with interest, as you repay the loan. However, if you carry a TSP loan into retirement, you have 90 days to pay off the balance. Otherwise, the TSP considers it a taxable distribution.
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