It is not uncommon for an employee to separate from federal service with an outstanding TSP loan. This article is about what will happen to that loan when you retire, or otherwise separate from federal service.
You are required to close out an outstanding TSP loan within 90 days of separation. Once the TSP Service Office is notified of your separation, they will send you instructions on closing out your loan. In those instructions, they will give you directions as to how to close it out and they will tell you the day by which it has to be closed. You will not be able to take any withdrawals from your TSP account until the loan has been closed.
You may close out your loan by:
- Repaying it in full; or
- Taking a taxable distribution; or
- A combination of the above.
If you take a taxable distribution, you will be liable for federal income tax (possibly state income tax, too) on the outstanding balance of the loan. IRS will be notified of the distribution. Federal income tax will be at your rate for ordinary income. If you separate before the year in which you reach the age of 55, you will also be liable for the 10% early withdrawal penalty.
If you have a Roth balance in your TSP account, the part of your loan that is associated with those Roth contributions will not be subject to federal income tax. However, any Roth earnings that are not considered qualified will be subject to federal income tax. For Roth earnings to be considered qualified, you must have had your Roth balance for at least five years and you must be the age of 59 ½ or over.
The TSP booklet “Loans” has more information about the TSP Loan program.