TSP hardship withdrawals: what they cost you

Hardship is one of the two in-service withdrawal types, and it is the one with conditions attached. The TSP does not let you decide what counts. Eligibility is limited to five named situations, and a general shortage of money is not one of them. You certify your need when you apply, so the categories are worth reading before you assume yours fits.

Two details narrow it further. You may only count expenses you have not already paid, and you may only count expenses that will not be reimbursed to you. A medical bill your insurer is still processing does not qualify while it might still be covered.

• Recurring negative monthly cash flow, meaning your ordinary expenses exceed your income month after month
• Unpaid medical expenses
• A personal casualty loss
• Unpaid legal fees from a separation or divorce
• Losses from a major natural disaster declared by FEMA

The permanent part is the part people underestimate. Money you take out cannot be repaid to the TSP later, so you lose the balance and every year of compounding it would have produced between now and retirement.

Then the tax. The taxable portion is taxed as ordinary income at your rate, and your state may tax it too. TSP withholds 10% of the taxable portion for federal tax automatically, though you can change that percentage, including down to zero. Withholding less does not reduce what you owe; it moves the bill to filing season.

On top of that, an additional IRS early withdrawal penalty of 10% may apply if you are under 59½. That penalty is separate from the income tax and separate from the withholding.

Two different six-month rules attach to hardship withdrawals, and people mix them up constantly. One was repealed years ago. The other still governs how often you can come back.

The repealed one froze your contributions. A hardship withdrawal used to stop your TSP contributions for six months, and a FERS employee lost agency matching for that whole stretch. The freeze often cost more than the tax did. It was eliminated as of September 15, 2019 under the TSP Modernization Act changes.

The surviving one limits how often you can go back. You cannot take a hardship withdrawal within six months of a previous one from the same account. So a hardship withdrawal leaves your contributions alone, but it does block another one for half a year.

A loan and a hardship withdrawal move money out of the same account, and that is most of what they have in common. A loan is repaid with interest that goes back into your own account, so the balance recovers. A hardship withdrawal is gone.

The tax treatment splits them just as sharply. A loan taken and repaid on schedule is not a taxable distribution and carries no early withdrawal penalty. A hardship withdrawal is taxable in the year you take it. Our lesson on TSP loans covers the repayment terms and what happens if you separate with a balance outstanding.

Your spouse is part of this. A financial hardship withdrawal requires your spouse’s consent if you are a FERS employee or a uniformed services member. For a CSRS employee it requires spouse notification rather than consent.

The lasting cost is the compounding you give up, not the tax you pay this year. A withdrawal taken decades before retirement removes the money and every dollar it would have earned between now and then. That is the arithmetic behind saving early, running backwards.

There is a floor on the account itself. Your balance must hold at least $1,000 of your own contributions and their earnings before a hardship withdrawal is available. That is a condition on the account, not a minimum you have to withdraw. TSP also publishes a worksheet for working out how much hardship funding your situation supports, for your records rather than for submission with the request.