Although many federal employees believe that they must wait until age 59 ½ before taking penalty-free withdrawals from their TSP, that isn’t the case. In fact, there are a few different ways that federal employees can take withdrawals before 59 ½ and avoid the 10 percent penalty usually applied to early distributions. In this article, we’ll focus on one method, the 72(t) Withdrawal, also known as the Substantially Equal Periodic Payments (SEPP) option. This withdrawal option allows separating federal employees to take a series of payments calculated using one of three approved methods to avoid the early withdrawal penalty. As great as this option may sound, it is subject to stringent rules that federal employees must understand before rushing in. Read on for a quick review of the nuts and bolts you should know before using the 72(t) Withdrawal option.
Note: Read more about withdrawing from your TSP here.
Three Methods
There are three approved methods for calculating your TSP (or IRA) substantially equal periodic payment amounts; they are the required minimum distribution (RMD) method, the amortization method, and the annuitization method. Each of the three methods uses life expectancy and other factors to calculate the payment amounts, and the results are different for each one.
The Required Minimum Distribution Method
The payments under this method are calculated by dividing the balance of the TSP by a life expectancy factor. Since the annual payment is recalculated each year using the account balance and life expectancy factor, the payment amounts will change from year to year. It’s worth noting that the RMD method will produce smaller payments than the other two methods, and once this method is selected, you cannot switch to another method.
The Amortization Method
The payments under the amortization method are calculated by amortizing the TSP account balance over a life expectancy and an interest rate not exceeding 120% of the federal mid-term rate. Unlike the RMD method, the amortization method has fixed annual payment amounts that cannot be changed in subsequent years.
The Annuitization Method
Under the annuity method, payments are calculated using an annuity factor and a chosen interest rate, with the same IRS guidelines as the amortization method. The annuity factor is derived using an IRS mortality table. Like the amortization method, the payments under the annuitization method are fixed.
Note: You can switch to the RMD method from either the amortization or the annuitization method. However, the switch is irrevocable, and you must continue to use the RMD method for the remainder of the time.
A Long-Term Commitment
A key consideration for any federal employee thinking about using the SEPP option is whether a long-term income stream is appropriate or required. The reason is that the SEPP payments must continue without modification for five years or until you reach age 59½, whichever is later (some exceptions exist).
So, for example, if Juan started SEPPs at age 49, he would have to continue the payments for ten years. On the other hand, if he began taking SEPPs at age 58, he would only have to continue until age 63.
A critical point to remember is that if payments are stopped or altered, all distributions made under the exception will be subject to the 10% penalty.
Final Thoughts
With many federal employees retiring early, SEPPs can be an excellent method for tapping into your TSP. However, because SEPPs have stringent complex rules and are inflexible, every federal employee should have a retirement income plan in place before pulling the trigger on the SEPPs option. If you don’t feel confident creating your retirement income plan or in your understanding of the SEPP complexities, you should consult with a qualified financial planner.
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2023 Legislative Change Notice
The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.
