If you haven’t been contributing to a 529 or pre-paid tuition plan for your child’s college tuition, you may be tempted to dip into your TSP to fund their education. Considering the high interest rate climate we find ourselves in, many parents are reluctant to saddle their children with excessive college loan debt. Before you make a substantial withdrawal from your TSP, there are a few things you should consider.
10% Early Withdrawal Penalties
When you withdraw from your TSP before you reach 59.5, you’ll be subject to a 10% penalty under IRS rules. Though the TSP does allow early, penalty-free “Hardship Withdrawals”, these are usually reserved for extreme financial needs such as avoiding foreclosure on your home. College tuition doesn’t qualify as a hardship under TSP rules.
Withdrawals From A Traditional TSP Are Taxable
Funds withdrawn from a tax-advantaged retirement plan like the traditional TSP or a 401(k), qualify as taxable income. When you withdraw a large sum, you run the risk of pushing yourself into a higher tax bracket in the year you make the withdrawal. Depending on where you live, your TSP withdrawal may also be subject to state income taxes.
Loss Of Investment Growth
Albert Einstein once described compound interest as the eighth wonder of the world. When your money makes money and then that money makes money, it creates a snowball effect that accelerates the growth of your investment. By decreasing the principal in your account, you reduce the amount of compound interest that you’re earning. This may cause you to delay your retirement or alter your plans to compensate for the loss of earnings.
Advantages Of A TSP Loan
Taking out a TSP loan to cover college tuition offers several benefits compared to a TSP withdrawal. Withdrawals are taxed as income and permanently lower your TSP balance. Additionally, if you’re under 59.5 years old, you’ll face a 10% penalty. In contrast, a TSP loan is not taxed, and money borrowed is repaid with interest via loan payments to your account. However, if you retire with an outstanding TSP loan, you must repay the balance within 90 days, or it will be treated as a taxable distribution.
Reach out to an FRC® trained advisor for more information.
