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One Mistake with TSP Withdrawals Can Lead to Penalties and a Tax Bill You Didn’t Expect

Missy E
November 14, 2025

Key Takeaways

Withdrawing from your Thrift Savings Plan (TSP) too early or without understanding the tax rules can result in avoidable penalties and unexpected tax bills.
Proper planning around required minimum distributions (RMDs), tax-efficient strategies, and age-specific rules is essential for maintaining retirement income and avoiding costly mistakes.

TSP Withdrawals Are Not As Simple As They Seem

If you’re like most public sector employees, your Thrift Savings Plan (TSP) represents a significant portion of your retirement income. But tapping into those funds isn’t as straightforward as it looks. Missteps—especially ones involving timing or tax rules—can leave you with penalties that shrink your savings and tax burdens that eat into your income.

In 2025, the IRS rules surrounding retirement withdrawals continue to be strictly enforced, and the cost of one mistake can be substantial. Understanding the regulations can help you avoid surprises and protect what you’ve worked so hard to build.

Age Matters: When You Withdraw Affects What You Owe

One of the most important factors in TSP withdrawals is age. The IRS imposes rules on when you can start taking money—and when you must.

Before Age 59 1/2

If you withdraw funds from your TSP before reaching age 59 1/2, you’ll generally owe a 10% early withdrawal penalty on top of regular income taxes. This applies to traditional TSP funds, which are tax-deferred. Even if you’re retired, this penalty still applies unless you qualify for an exception, such as the “age 55 rule.”

The Age 55 Rule

If you separate from federal service in or after the calendar year you turn 55 (or 50 if you were in a special category like law enforcement), you can take penalty-free withdrawals. However, this exception only applies to the TSP—not IRAs. Rolling your TSP into an IRA too early can eliminate this benefit.

After Age 59 1/2

Once you pass 59 1/2, you can withdraw from your TSP without the early withdrawal penalty. But that doesn’t mean you’re free from taxes. Traditional TSP distributions are taxed as ordinary income in the year you take them.

Required Minimum Distributions (RMDs) Begin at 73 in 2025

Under current law, you must begin taking required minimum distributions (RMDs) from your TSP by April 1 of the year after you turn 73. This change, which took effect in 2023 under the SECURE Act 2.0, moved the RMD age from 72 to 73. If you turned 73 in 2025, your first RMD must occur by April 1, 2026.

Failing to take the required amount results in a significant penalty—25% of the amount you should have withdrawn. If corrected in time, the penalty may be reduced to 10%, but this still represents a steep price for missing a deadline.

Make sure you:

Track your birthday and know your first RMD year.
Calculate your RMD using the IRS life expectancy tables.
Take the RMD annually by December 31 after your first RMD year.

Taxes Are Inevitable—But You Can Minimize Them

TSP withdrawals are generally taxed as ordinary income. But the way you structure those withdrawals can significantly affect your tax burden.

Traditional vs. Roth TSP

Traditional TSP: You pay taxes on withdrawals.
Roth TSP: Qualified withdrawals are tax-free. To qualify, you must be at least 59 1/2 and have held the Roth TSP account for at least five years.

Avoiding Big Tax Hits

Large lump-sum withdrawals can push you into a higher tax bracket. Instead, consider systematic withdrawals that keep you in a lower bracket. Spreading out distributions over multiple years may help control your tax bill.

Be cautious when withdrawing in a year you also receive other taxable income (like a CSRS or FERS annuity, Social Security, or spousal income), as it can compound your tax liability.

Automatic Withholding Doesn’t Always Match Your Tax Owed

TSP automatically withholds 20% for federal income taxes on most eligible withdrawals. However, this does not guarantee you’ve covered your full tax liability.

For example:

If your actual tax bracket is 24%, you may owe more when you file your return.
If your bracket is lower, you may receive a refund, but you’ve given the IRS an interest-free loan.

You’re responsible for making sure your total tax payments (including withholding and estimated taxes) meet the IRS’s safe harbor thresholds. Otherwise, you could face underpayment penalties.

Special Considerations If You’re Still Working Past 73

If you’re still employed by the federal government and contributing to your TSP, you’re generally exempt from taking RMDs from your current TSP account. But if you have other retirement accounts (like IRAs or old employer plans), RMDs from those may still be required.

This working exception only applies to the plan with your current employer. If you separate, even mid-year, you’ll become subject to RMDs in that year if you’ve reached age 73.

Loans Left Unpaid Become Taxable Events

TSP loans can help while you’re working, but they must be repaid before you separate or retire. If not, the unpaid balance becomes a taxable distribution.

Here’s what happens:

The unpaid balance is reported as income.
You may owe the 10% early withdrawal penalty if under age 59 1/2.
You’ll lose the ability to repay the loan once it’s treated as a withdrawal.

Before you retire, make sure you:

Repay outstanding loans in full.
Or prepare for the tax consequences.

Rollover Mistakes Can Trigger Immediate Taxation

You may want to roll your TSP into an IRA or another employer plan. Done correctly, this can preserve tax-deferred status. But if you make a direct withdrawal instead of a trustee-to-trustee transfer, it’s considered a distribution.

This means:

The TSP withholds 20% for taxes.
You must deposit the full amount (including the 20% withheld) into the new account within 60 days.
If you don’t, the withheld amount becomes taxable.

Unless you have extra cash to cover the withheld portion, you’ll pay tax—and potentially penalties—on it.

One-Time Withdrawal Options vs. Series: Choose Wisely

You have several options when withdrawing from your TSP in retirement:

Installment payments: Monthly, quarterly, or annual.
Single withdrawals: One-time lump sums.
Mixed strategy: Combination of the above.

The TSP allows you to change installment payments at any time, but making too many large one-time withdrawals without considering the tax impact can trigger higher liabilities or even Medicare IRMAA surcharges if your income spikes.

A well-thought-out withdrawal schedule helps you stay in control.

Survivor Considerations: Mistakes Don’t Just Affect You

If you pass away, your TSP balance can transfer to your beneficiary—but the tax rules still apply. Spouses can roll inherited TSP funds into their own retirement account to delay taxation. Non-spouse beneficiaries may have to withdraw the full amount within 10 years under current law.

Make sure to:

Keep your beneficiary designations current.
Educate your heirs about tax implications.

A mistake here can reduce the legacy you leave behind.

Planning Around Life Changes and Major Expenses

Major events—like divorce, medical emergencies, or home purchases—can tempt you to withdraw large amounts from your TSP. While the funds are there to support your retirement, reacting emotionally to a sudden expense can trigger penalties or poor tax timing.

Before making any decision:

Consult a tax professional.
Consider partial withdrawals or phased distributions.
Explore non-TSP resources first if you’re under 59 1/2.

Why Professional Advice Can Be Your Best Defense

The TSP is a powerful retirement tool, but it comes with strict rules that can be easy to violate accidentally. Whether you’re preparing to retire, already separated, or managing withdrawals, having a strategy matters.

Avoiding unnecessary taxes and penalties starts with knowing the rules—but it ends with smart decisions that align with your income needs and retirement goals.

Protecting Your Retirement from Preventable Losses

The goal of the TSP is to support your retirement—not punish you for taking your own money. But unless you understand the specific timelines, tax rules, and distribution strategies involved, your withdrawals can do more harm than good.

Don’t let confusion or guesswork guide decisions that will affect your financial future. If you need guidance, speak with a licensed agent listed on this website who can help tailor a withdrawal plan that works for you.