TSP Hardship Withdrawal Requirements and Pros & Cons

Table of Contents

1. What are the Rules for a Financial Hardship Withdrawal?
1. Other Ways the IRS Prevents TSP Hardship Abuse
2. What Happens After the Hardship Withdrawal?
3. TSP Hardship Withdrawals: Pros & Cons
1. Advantages of a Hardship Withdrawal
2. Drawbacks of Hardship Withdrawal
3. Early Withdrawal Penalties and Avoidance Strategies
4. Scenarios When Withdrawing Makes the Most Sense
5. Scenarios When Withdrawing Makes Less Sense
4. Is a Hardship Withdrawal Worth It?

The Thrift Savings Plan (TSP) has a feature that allows its members to withdraw money during a financial emergency. While this can be helpful in a tight situation, it is not a decision to take lightly. When money is taken out early, it cannot be replaced in the TSP, and you will lose out on any potential growth from those funds.

The TSP is designed similarly to a 401(k) plan, a long-term retirement savings plan with tax deferral advantages. It is not designed to be a temporary savings account or to be tapped into before you are usually eligible, typically age 59 1/2. To deter people from taking early withdrawals, taxes and penalties are incurred in addition to the inability to replace withdrawn funds. Strict restrictions are also in place to determine who is eligible for early withdrawals.

What are the Rules for a Financial Hardship Withdrawal?

TSP members only qualify for financial hardship withdrawals if the federal government still employs them. The amount of the financial hardship withdrawal is limited to your financial need, but you cannot withdraw less than $1,000. You may be able to withdraw both your contributions and earnings, but as previously mentioned, you cannot replace any of these funds once they are withdrawn.

To be eligible for a hardship withdrawal, your financial need must result from any of these four conditions:

1. Negative Monthly Cash Flow: When your net income is repeatedly less than your expesnses. To determine negative cash flow, you can utilize the worksheet provided with the Financial Hardship Withdrawal Request (Form TSP-76). You do not have to return the worksheet with your request for a financial hardship withdrawal. However, you will be required to affirm under penalty of perjury that you have a genuine financial hardship as well as the reason for the hardship. Maintaining a copy of this form for your records is a good idea.
2. Medical Expenses (including household improvements needed for medical care): Unpaid medical expenses eligible for federal income tax deduction due to medical conditions, illnesses, or injuries affecting you, your spouse, or your dependents at the time of your financial hardship withdrawal request. This includes unpaid expenses for household improvements needed because of these medical conditions, such as wheelchair ramps, railing and support bars, modified doorways and stairways, or elevators. 
3. Personal Casualty Losses: Damage, destruction, or loss of property from sudden, unexpected, or unusual events like earthquakes, hurricanes, tornadoes, floods, fires, or theft, excluding losses caused by your own willful negligence. Costs for repairs and replacements that qualify for a federal income tax deduction, irrespective of IRS income limits, fair market value, or event frequency, are covered. However, ineligible losses include those due to normal wear and tear, business or income-producing property damage, and loss of deposits due to financial institution failure.
4. Legal Expenses: Limited to unpaid legal fees and court costs related to a separation or divorce from your spouse.

Spousal consent is required for FERS employees and members of the uniformed services to withdraw funds due to financial hardship while CSRS employees only need to notify their spouse. For detailed information on eligibility and the application process, please refer to In-Service Withdrawals. This ensures adherence to regulations and maintains transparency in the withdrawal process.

Other Ways the IRS Prevents TSP Hardship Abuse

The IRS has other rules to follow before making a hardship withdrawal from your Thrift Savings Plan. 

• The withdrawal must meet an immediate and heavy need. This stipulation helps define hardships as current and serious problems and not anticipated or minor problems.
• The withdrawal must be the only option available to meet the need. Do you have other options to solve the problem? Exhaust those first.
• The withdrawal must satisfy the need. Amounts above the need are not permitted: you can’t withdraw a little extra to smooth things over for a few months. The withdrawal must be used exclusively for the specified hardship.
• The withdrawal cannot come before all non-taxable distributions or loans have been obtained from the TSP. You’ll have to wait until after you’ve gotten your scheduled distributions (if you’re old enough to receive distributions) before seeking a hardship withdrawal.

What Happens After the Hardship Withdrawal?

Before September 15, 2019, you could not contribute to your TSP account for six months after a hardship withdrawal. If you partcipated in FERS, you would not recieve any Agency Matching Contributions because you were not eligible to contribute to the TSP. After the six-month waiting period or after September 15, 2019, you also had to change your contribution election form to resume contributions.

Though, after September 15, 2019, this rule was eliminated by the Federal Retirement Thrift Investment Board (FRTIB), and a hardship withdrawal no longer has any effect on contributions to your TSP account. 

However, you will not be able to apply for another financial hardship withdrawal request until six months have passed. 

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TSP Hardship Withdrawals: Pros & Cons

Like any important financial decision, you should take a few minutes to consider the pros and cons of making a TSP hardship withdrawal.

Advantages of a Hardship Withdrawal

The advantage of making a hardship withdrawal is clear and simple: you can access your money in a qualifying emergency.

This can prevent the hardship from worsening and keep you from seeking solutions like loans or credit cards which often have high interest rates.

Also, unlike a TSP loan, hardship withdrawals do not have to be repaid into your TSP account, so you won’t have to add another monthly loan payment to your budget.

Drawbacks of Hardship Withdrawal

Even when you have a great reason to withdraw money from your TSP before retiring, the fact remains that you are taking a distribution from your retirement account for purposes other than retirement.

By taking money out of your account now, you’re preventing that money from growing in the future, which is one of the main reasons to have a TSP account.

Hardship withdrawals are not free. Treated as a distribution, the TSP will automatically withhold 10% of the funds you withdraw for federal income tax unless you instruct them to withhold a different amount. You will also incur a 10% early withdrawal penalty if you are not at least age 59 1/2. 

Early Withdrawal Penalties and Avoidance Strategies

There are exceptions to the 10% penalty on withdrawals made before age 59 ½ for circumstances such as death, disability, and certain medical expenses. Additionally, some plans allow penalty-free withdrawals starting at age 55 if the participant separates from employment in or after the year they turn 55.

Another key rule, Rule 72(t), mandates that participants that take substantially equal periodic payments (SEPPs) over at least five years are exempt to the 10% additional tax. However, this is subject to strict IRS guidelines.

First-time homebuyers may also withdraw from a Roth IRA without penalty. Less commonly known are Qualified Reservist Distributions (QRDs), which enable Reserve and National Guard members to make early withdrawals from their TSP & IRAs penalty-free if they were mobilized after September 11, 2001, for at least 180 days or an indefinite period, and take the distribution during that period. While these withdrawals are still subject to income taxes, no penalties are charged. Furthermore, if not needed, the withdrawal can be repaid to the IRA within two years, and QRDs apply to various tax-deferred accounts like IRAs, 401(k)s, TSPs, and 403(b)s.

Scenarios When Withdrawing Makes the Most Sense

Only you can know your precise situation, but here are some scenarios in which a hardship withdrawal may make the most sense:

• If you anticipate a substantial tax refund
  • This would be easier to manage the taxes on the funds you withdraw.
• If your monthly budget simply won’t allow the addition of another loan payment from either a TSP loan or a commercial loan from your bank or credit union
• The money you’re saving in your TSP account represents a less significant portion of your retirement plan.
  • For example, most of your retirement savings are in other investments you can’t access.
• If you’re 59-½ years old or older since you can avoid the 10% distribution penalty
• If you’re permanently disabled and can withdraw money penalty-free (though not tax-free)

Scenarios When Withdrawing Makes Less Sense

Again, your situation is unique, and you should treat it that way, but here are some times when hardship withdrawals may make less sense or be ill-advised:

• If you are filing for bankruptcy
  • Your TSP account could shield those assets from seizure. Your bankruptcy attorney should advise you about these specifics.
• If you have not saved or planned for retirement other than your TSP account
• If you already expect to owe taxes next year and are unsure how you’ll pay them
  • A hardship withdrawal from your TSP is generally taxable as ordinary income. This means the amount you withdraw will be added to your taxable income for the year, potentially pushing you into a higher tax bracket and increasing the amount of tax you owe.
• If you are younger than 59-½ years old and would lose an additional 10% of the withdrawal in penalties

As you make this decision, weigh your options carefully and consider your individual needs, both current and future.

Is a Hardship Withdrawal Worth It?

In the most urgent cases, you can probably justify it. But because you will have to pay taxes, possibly pay a lot in penalties, and limit the potential for the growth of your retirement funds, this may not be the best option. I would strongly consider applying for a loan before paying these taxes and penalties. As with everything, your situation is unique, and you should consult a professional financial advisor before deciding whether or not to pursue this avenue.

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