The majority of federal employees put their retirement savings into the TSP while also taking loans from their TSP account. You can use the TSP loan for many purposes, such as a down payment on your home. It has less burden because the interest you pay will eventually go back into your TSP account’s G Fund.
Despite the TSP loan benefits, you need to understand these three things before you take the loan.
Opportunity Cost
When you take a TSP loan, the loan’s interest is equal to the G Fund’s return when your loan application is approved. Currently, the G Fund’s return rate is 0.75%, and this return rate will be the interest rate on the TSP loan. If the G Fund’s return does not increase while you are repaying your TSP loan, the loan will have the same value as if you keep the money in your G Fund during this period.
Over the past years, the 2-3% rise in inflation has been the major problem with the TSP loan. This change in inflation rate implies that when you take the TSP loan or you invest in the G Fund, you will lose some money when an adjustment for inflation is put into consideration. Most federal employees invest in other funds so that their retirement savings can be in line with the rising price.
When you take the loan, your money will not grow as it is supposed to grow, then you cannot make more money from the savings in your TSP account. Taking the TSP loan will affect your total balance when you retire.
High Tax Bill
Many federal retirees now know that having an unpaid balance on their TSP loan when they leave or retire from their work serves as a taxable distribution, resulting in a higher tax bill. Retiring with an unpaid balance affects people who don’t have enough money to pay these extra taxes. Federal employees who retire before they are 59 ½ years of age may face penalties when they pay the loan back.
Do you pay taxes twice?
When you save into the traditional TSP, you will have a tax deduction, but you will pay taxes on both the money and its growth over time when you withdraw your savings at retirement. When you take the TSP loan, you don’t pay taxes immediately, but you will pay taxes when you pay back the loan. When you pay back the loan, you are using the after-tax dollar to repay the loan so that you will pay taxes along with it. During your retirement period, you will pay taxes on any withdrawal you make.
Some people believe that you are not paying double tax since you are introducing new money when you pay back the loan. No matter your view about this, you will pay extra taxes when you take the TSP loan.
Taking the loan is beneficial when you urgently need money, but you should not consider the TSP loan as your regular source of funds. There is an indication that you do not save enough for emergencies when you take the loan regularly. It is better to find other sources of money than taking the TSP loan because doing so will ultimately affect you when you retire.
