New legislation aims to broaden the scenarios in which federal employees can withdraw from their Thrift Savings Plan (TSP) penalty-free following their departure from federal service.
The bill, known as Frugal savings plan emergency withdrawal method (HR6929), was put forward by Congresswoman Eleanor Holmes Norton (D-DC). It would permit recently separated federal employees to withdraw from the TSP without incurring penalties under two specific conditions:
- Receiving an interim pension after retirement
- Involuntary separation from federal service
In these cases, individuals may withdraw a maximum of $100,000. They can evade the standard 10% early withdrawal penalty by making withdrawals within one year of separation and repaying the amount within three years.
What is an interim pension?
Upon retirement, federal employees receive interim pension payments until the Office of Personnel Management (OPM) finalizes their retirement application. According to OPM, these interim payments usually amount to 60 to 80 percent of the full pension and are designed to assist with expenses while the retirement process is completed.
Currently, the OPM estimates that processing a retirement application takes, on average, three to five months.
The bill is intended to mitigate financial strain for those only receiving partial pensions during the initial months post-retirement. However, depending on TSP withdrawals for bridging this income gap might not always be the best approach. Some preemptive planning or adjustments in budgeting could offer alternative solutions.
Retirement doesn’t happen overnight, and a solid strategy could involve setting aside savings to compensate for lower interim pension payments. Federal employees might consider maintaining a separate savings account to cover essential expenses for a defined period (let’s say four to six months) right after retiring. This way, by their retirement date, they would have enough saved to manage those reduced payments without needing to tap into the TSP immediately.
Things to keep in mind when using TSP as an emergency fund
This proposed legislation seems to offer a lifeline for federal employees dealing with financial difficulties. Yet, withdrawing funds from the TSP—especially for those who haven’t reached retirement age—can come with some notable drawbacks.
Taking money out of a TSP reduces the total account balance, which translates into lost investment opportunities. This is particularly an issue during favorable market conditions, like we’ve seen lately.
For instance, the C Fund recorded returns of 26.25% in 2023, followed by 24.96% in 2024, and has seen around 19.29% so far in 2025. So, reducing your TSP balance by $100,000, even temporarily, can lead to a significant decline in your earnings over time.
To illustrate, consider two scenarios: one account starting with $500,000 and another starting with $400,000—both assuming no additional contributions. After a year, with a 19% return, the balances and profits differ markedly.
After three years at the same 19% return rate, the discrepancy grows even larger, leading to a considerable loss of compound interest for the account that was reduced.
A better approach
With some foresight, there are certainly better avenues to avoid this financial squeeze entirely.
One alternative is to create an emergency fund. Financial experts often suggest setting aside three to six months’ worth of household expenses in a savings or money market account to prepare for unforeseen circumstances.
For example, if monthly expenses are around $2,500, one could aim for an emergency fund ranging from $7,500 for three months to $15,000 for six months.
This planning is particularly crucial for those under 59 ½, as they face a potential 10% early withdrawal penalty when tapping into TSP funds. Currently, the legislation states that any withdrawn amounts must be repaid within three years to evade this fee.
While this new bill could offer short-term assistance to federal employees grappling with financial issues, depending on the TSP as a reactive measure at a younger age might have significant repercussions for long-term retirement planning. Losing out on compounding returns can severely impact overall retirement savings, especially in strong market periods. So, even if it becomes necessary to withdraw from TSP during tough times, it’s generally advisable to reserve those funds strictly for retirement rather than emergencies.
