Military Finances 201: What to Consider Before You Take a TSP Hardship Withdrawal or Loan

The TSP is designed as a retirement planning tool, but investors sometimes face unexpected financial situations that lead them to consider withdrawing funds from their TSP early. While a TSP is designed for long-term savings, you can access the funds early through hardship withdrawals and loans. However, there are consequences to this decision.

Here, we break down TSP hardship withdrawals and note what you should consider before accessing your retirement funds early. By the way, the same rules apply to 401(k)'s and 403(b)'s.

What Are TSP Hardship Withdrawals?

A hardship withdrawal allows you to access your retirement savings early (before the age of 59 ½), but only under specific conditions.¹ The IRS defines hardship as "an immediate and heavy financial need" and limits withdrawals to the amount necessary to satisfy that need.

Common reasons for a hardship withdrawal include:

Medical expenses for you, your spouse, or dependents
Preventing foreclosure or eviction from your primary residence
Funeral expenses for a family member
Tuition and related educational fees
Repairs for damage to your principal residence

Key Considerations for Hardship Withdrawals

If you have a significant nest egg saved in your TSP account, it may be tempting to want to access those funds to cover an immediate and heavy financial need. Still, there are some serious considerations you should take into account before doing so.

While hardship withdrawals are permitted in some instances, they still come with penalties. You will owe both federal and state income tax on the amount withdrawn, and if you are under the age of 59½, you'll also potentially face a 10% early withdrawal penalty in most cases.²It is worth noting though, that as of 1 Jan 24 withdrawals for an emergency personal expense or in case of domestic abuse are not subject to penalty (the amount you can take out is limited though)

In addition to the penalties and taxes, taking a hardship withdrawal reduces the amount of tax-deferred money growing in your account, which could severely impact your future retirement security.

Lastly, unlike a TSP loan, a hardship withdrawal cannot be repaid (except in the case of some COVID withdrawals). Thus, the funds are permanently removed from your retirement savings. This consideration is critical because once those funds are withdrawn, you lose the principal and the potential for future earnings.

What Are TSP Loans?

A TSP loan is another option for accessing your retirement funds, but it works differently from a hardship withdrawal. With a loan, you borrow money from your TSP and agree to repay it, typically with interest, over a set period.³

With TSP loans, you’re required to repay the loan, usually through payroll deductions. If you leave your job, the loan must typically be repaid in full within a short time frame, or it will be treated as an early withdrawal subject to taxes and penalties.

When you take a TSP loan, you’re also required to pay interest on the loan. The good news is that this interest is paid back into your account, so you’re essentially paying yourself. However, the opportunity cost of having that money out of the market could outweigh the benefits.

Lastly, you can only borrow up to 50% of your vested account balance or $50,000, whichever is less. If you have a small balance, this might limit the amount you can access, making a loan less helpful in a major financial emergency.⁴

Alternatives to Consider Before Accessing TSP Funds

Before turning to a TSP loan or hardship withdrawal, it’s important to explore other financial options. Here are a few alternatives to consider:

Emergency Savings

Ideally, you should have an emergency savings account to cover unexpected expenses. Accessing these funds instead of your 401(k) preserves your retirement savings.

Personal Loans

Sometimes, a personal loan or home equity line of credit (HELOC) might be a better option. While these loans have interest, they don’t impact your retirement savings.

Credit Counseling

If you're experiencing financial hardship, working with a credit counselor or financial advisor can help you develop a plan that doesn't involve dipping into your retirement funds.

Life happens, which sometimes means you must pay for a large expense you didn’t see coming. While withdrawing the amount from your 401(k) is one option, there are a few considerations that investors should remember before taking out the funds.

Military Finances are Different

As mentioned above, these rules apply to TSP and other similar civilian retirement plans. With that said, a military member may have a tax-exempt balance in his or her TSP. There is no equivalent in civilian retirement plans. That's not the only way military finances vary from civilian finances. That's why we think Active or Retired Senior Military Officers and NCOs should work with a financial planner that deals with your unique issues each and every day. If you'd like to find out how we work with clients just like you, use the button below to schedule a free, initial consultation.

If you found this article useful, you might like the following blog posts:

I'm About to Retire From the Military. What Should I Do With My TSP?

One Reason to Consider Moving Your Assets Out of TSP - Estate Planning

Roth TSP in a Combat Zone: Almost a "No Brainer"

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.