If you haven’t been contributing to a 529 plan or a prepaid tuition program to save for your child’s college education, you might be considering tapping into your Thrift Savings Plan (TSP) to cover these costs. With today’s high interest rates, many parents are hesitant to burden their children with substantial student loan debt. However, before withdrawing a significant sum from your TSP, it’s important to weigh several key factors.
10% Early Withdrawal Penalty
If you withdraw from your TSP before reaching the age of 59.5, the IRS imposes a 10% early withdrawal penalty. While the TSP offers penalty-free “Hardship Withdrawals,” these are limited to severe financial circumstances, such as preventing foreclosure on your home. Unfortunately, college tuition does not qualify as a hardship under TSP guidelines.
Taxes on Traditional TSP Withdrawals
Any funds withdrawn from a traditional TSP or similar tax-advantaged retirement account are considered taxable income. If you withdraw a large amount, you may unintentionally bump yourself into a higher tax bracket for that year. Furthermore, depending on your state’s tax laws, your TSP withdrawal could also be subject to state income taxes.
Loss of Compound Growth
Albert Einstein famously referred to compound interest as the “eighth wonder of the world.” When your investments grow, and those gains are reinvested, it can create a powerful snowball effect, significantly boosting your savings over time. By withdrawing money from your TSP, you reduce the principal, which means you’ll earn less compound interest going forward. This reduction in growth could potentially delay your retirement or force you to make adjustments to your retirement plans.
Benefits of a TSP Loan
Instead of withdrawing funds, consider taking out a TSP loan to cover college expenses. Unlike a withdrawal, a TSP loan is not taxed, and you repay the loan—along with interest—directly into your account, preserving your overall TSP balance. However, it’s important to remember that if you retire with an outstanding TSP loan, the unpaid balance must be repaid within 90 days. If not, it will be treated as a taxable distribution.
For more personalized advice, reach out to an FRC® certified advisor.
