Besides their home, the Thrift Savings Plan (TSP) is quite often the most significant investment for federal employees under the Federal Employee Retirement System (FERS). The TSP gives opportunities for loan programs allowing employees to borrow money from their accounts if needed.
For someone in need of cash or looking to make a large purchase (like a home that they need a down payment for), or someone needing to cover some general expenses or pay down some credit card debt this can seem pretty enticing at first.
After contributing for years through payroll deductions, they can dip into what they have built up in their TSP. However, that may not always be the best option, but before we get into that let’s look at the types of loan programs available.
The residential loan and the general-purpose loan are two loan programs offered through the Thrift Savings Plan:
The Residential Loan Program: This loan program is available for federal employees looking to gather the funds needed for a down payment (or for closing costs) when purchasing a house. Over the course of 15 years, these loans can be paid back, and documentation on the property is required.
The General-Purpose Loan Program: This loan program can be paid back over the course of up to 5 years. There is no documentation required as this loan can be used for any purpose. Typically, paying the loan back consists of regular payroll deductions. However, you can send in a direct payment if you wish to pay off the loan in full, or even to reduce the balance.
Reasons Not to Take a TSP Loan
There are some important reasons to consider if you’re thinking about a TSP loan. These loans aren’t always as attractive as they may seem.
The first and most apparent reason TSP loans may not always be the best choice is that you lose gains that the money would have generated. Interest can be compelling over time when it comes to savings growth.
At the time of your loan, which remains fixed, the TSP charges the G Fund rate, and you pay this rate back to yourself. Earnings that could have been made are sacrificed as they could have been invested somewhere other than the G Fund had the money stayed in the account.
It is essential to keep in mind that the money you’re paying back through payroll deductions is after-tax money. When paying back your loan, you must return every dollar you withdrew plus the effective tax rate.
At retirement when it’s time to make withdrawals from your TSP, the money will be taxed at standard income tax rates. The funds that you paid back with after-tax funds will still be taxed at that standard income rate because there is no distinction.
Because of this, part of your TSP will be taxed twice:
1. During loan repayment
2. During withdrawal of funds
There can be the risk of voluntarily reducing regular TSP contributions once the TSP has been borrowed against. If the loan payback schedule is no longer affordable on top of the continuing regular TSP payroll deductions then cutting back on the TSP contributions, in general, may be a fallback option. If this occurs, then the loan could cause them even to reduce their overall retirement savings and long-term plan. As a result, the ability to retire on time may be compromised.
Overall, the TSP loan program does offer some limited access to your funds before you separate from the government or retire. Even so, those that are not fully informed on both the hidden and apparent costs could potentially suffer and pay the steep price.