When unexpected bills upset your plans

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The Thrift Savings Plan is intended to fund retirement living expenses, but it might be necessary to tap it early to meet unexpected expenses. Frozen pay, furloughs, reductions-in-force and earlier-than-expected retirement can throw a monkey wrench into the best of plans.

Of course, reducing your spending to avoid invading your TSP account should be your first tactic. A loan is another option, but there are limits on the amount you can take, and it must be repaid in installments. Sometimes a loan just won’t do the job.

So, how do you get at that TSP money?

If you have reached age 59½ and are still working, you may take one age-based, in-service withdrawal without penalty. This will count as your only lifetime partial withdrawal, so don’t plan on taking another later.

If you separate from federal service during or after the calendar year you reach age 55, you may withdraw funds, according to the normal rules for retirees, without penalty. This is a special exception to the early withdrawal penalty that applies only to employer-sponsored retirement plans, like the TSP, and not to IRAs.

If you’re still a federal employee and are under age 59½, you have two options — a loan or a financial hardship withdrawal. As I mentioned, a loan is a good choice if you don’t need more than is allowed and can afford to make the required repayments. A hardship withdrawal requires documented proof of the need and is subject to the 10 percent IRS early withdrawal penalty and income taxes, so it should be your last resort.

But what if you’re separated from service and don’t meet the age 55 exemption?

One way to avoid the early withdrawal penalty is to use all or part of your balance to purchase a life annuity, either from the TSP’s provider or from another insurance company. The annuity converts your balance into a stream of income guaranteed to last at least as long as you live and on which you will pay no early withdrawal penalty. The annuity is irreversible, however, and may produce a stream of income significantly smaller than what could be produced through alternative withdrawal methods. More important, it may produce a stream of income that fails to keep pace with inflation and reduces your spending power through time. Select this option only after careful consideration and comparison against alternatives.

Rather than purchasing an annuity from an insurance company, you can also avoid the early withdrawal penalty by creating and managing your own annuity — taking withdrawals designed to distribute your account balance over your lifetime. The IRS allows three alternative methods to be used in calculating the penalty-free distribution — called substantially equal periodic payments — that can be taken from an account each year: the life expectancy method, the annuity factor method and the amortization method.

The life expectancy method calculates each year’s distribution by dividing the previous year’s ending balance by your remaining life expectancy, according to published tables. The result will be annual distributions certain to last your lifetime, but which may vary substantially in size from one year to another.

The annuity factor and amortization methods both rely on complex formulas that produce fixed annual distribution amounts that may or may not last for life. These two methods typically produce distributions that are higher than by the life expectancy method.

All of the substantially equal periodic payment exemptions require that the distributions continue, undisturbed, for five years or until you reach age 59½, whichever is longer. This means that once the distributions begin, they must continue and must not change, except as allowed, for at least five years. You must take exactly the amount produced by an accepted calculation method each and every year, without adding any money to the account, during the required period to avoid penalties.

Violating the rules will mean that penalty taxes and interest will be imposed on the entire stream of early distributions taken.

Additional exemptions to the penalty for distributions taken from your TSP account before you reach age 59½ are those:

• Made because the account owner is totally and permanently disabled.

• Ordered by a domestic relations court.

• Made because the account owner died.

• Made during a year in which the account owner has deductible medical expenses exceeding 7.5 percent of adjusted gross income.

• Made by an account owner who separated from federal service during or after the calendar year in which he reached age 55.

If you qualify for one of these exemptions, you will have unlimited access to your account after you separate from service at any age, without penalty.

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