If you are a federal employee or have a family member who is, then you know that the Thrift Savings Plan (TSP) is one of the cornerstones of a government benefits package.
As with many non-federal savings plans, it is possible to take out a loan on your Thrift Savings Plan.
However, most experts, including those at the Office of Personnel Management (OPM) will tell their clients to exhaust every other loan option before touching their TSP accounts.
Before examining the downside of tapping into your Thrift Savings Plan, let’s look at why many employees opt to borrow from a TSP, despite all the caveats.
Getting a Loan is Fairly Straightforward
When you take out a TSP loan, you are borrowing money from your account. The amount of this loan cannot exceed your contributions and interest earned from those contributions. If you are under FERS (Federal Employees Retirement System), you cannot borrow from any agency contributions or earnings on agency contributions.
Once you’ve met current loan eligibility rules and your request is approved, the requested amount drafts from your account. You are responsible for repaying the loan, plus interest, within a specific time frame.
There Are Many Permissible Loan Amounts Available
Depending on how much money is in your account, the government allows you to borrow anywhere from a minimum of $1,000 up to $50,000. This flexibility is appealing to many people, especially those who don’t have a lot of savings in their regular bank accounts and need cash quickly. If you log into the TSP website (https://www.tsp.gov/index.html), you’ll find a useful calculator for estimating your loan payments.
The General- Purpose Loan Requires No Documentation
There are two types of loans currently allowed by your TSP, a general-purpose loan or a residential loan.
While the residential loan may only be used to purchase or build a primary residence and requires documentation, the general-purpose loan may be used for any purpose and does not require documentation. Note that residential loan terms are a maximum of 15 years, so they are probably not your best option for buying a home.
Low-Interest Rates on Loans
Obviously, in the current environment, low-interest rates aren’t as much of a factor as they were a few years ago. Still, it’s worth noting that TSP rates, which are the same as the return rate on the G Fund, were attractive to many government employees over the years.
Automatic Payroll Deduction Payments
Many federal employees enjoy the convenience and ease provided by automated payroll deduction payments on their loans. This automation prevents employees from missing payments and getting behind on re-payment.
Now that you have seen some of the PROS of borrowing from your TSP let’s see the CONS that make financial expert hesitate to recommend these kinds of loans. Here are a few of the most compelling downsides to taking money from a Thrift Savings Plan.
Missing Out on Potential Earnings
Just as with a 401k or IRA, there is a significant disadvantage in borrowing from your TSP. Think about it: You are, in essence, borrowing money from your future. When you take money from the TSP, you lose any investment growth you would have earned. You also must pay back YOUR OWN MONEY with interest! At Genuine Financial Advisors, we show our federal employee clients alternatives to TSP loans that will allow their money to grow safely, without market risk. What if I told you there was an alternative to TSP loans that enables you to borrow but gives you growth as if you never touched a penny?
There is a potentially huge TAX TRAP
If you leave service with a balance on your TSP loan, you must repay that balance within 90 days or face a tax trap. If you fail to pay off the entire loan within 90 days, it will be reported to the IRS and trigger what’s known as a “taxable event.” This could wind up subjecting you to a big tax bill depending on the loan’s size and other factors.
Loan Terms Are Short
As I mentioned before, the most extended term for a TSP loan is 15 years for a primary residence loan. Of course, such a short loan term will mean that your mortgage payments might be a lot more than you want to pay. TSP should be considered a lender of last resort for purchasing a home. General-purpose loans have an even shorter-term- a maximum of 5 years.
Implications for Retirement
If you still owe money on a TSP loan after you retire, be aware that you are repaying that loan with after tax money. When you retire, you are paying tax on your withdrawals. So, TSP loans create a double taxation situation of which you should be aware. If you have TSP loans and you are getting ready to retire, I highly advise consulting with a Federal benefits specialist as soon as possible.
Most any kind of debt carries with it expenses that can have both short-term and long-term consequences. Even if you are a federal employee who believes you will never have to borrow money, it’s good to sit down with a professional who understands both conventional financial vehicles and the complexities of federal benefits.
A trusted, smart planner can evaluate your situation, taking into account all your government-provided options as well as products outside your plan that could work more efficiently for you. An outline of action should be developed in the event you want or need to borrow money. The potential effects of loans on your retirement goals should always be a prime consideration.
Always choose a firm that can help you navigate the often-confusing world of your benefits package and knows alternative products and strategies that work best with your benefits.
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