For most federal employees under the Federal Employee Retirement System (FERS), the Thrift Savings Plan (TSP) is their largest investment asset outside their home. The Plan offers loan programs which allow federal employees to borrow money from their accounts.
This feature is very enticing for someone that has a need for cash to place a down payment on a home purchase or just general expenses they want to take care of. They can tap the dollar value they have built up in their TSP after contributing for years through payroll deductions.
Loan Programs
There are two loan programs available through the TSP: the residential loan and the general purpose loan.
The residential loan program is available to assist in putting together the funds required for a down payment or to help pay for closing costs on a home purchase. These loans can be paid back for up to a fifteen-year period and require documentation on the property.
The general purpose loan can be paid back for up to five years. It can be used for any purpose and does not require documentation. Payback is typically in the form of regular payroll deductions, although you can send in a payment to pay off the loan or reduce your balance.
Reasons Not to Take a TSP Loan
There are four reasons why these loans aren’t as attractive as they appear to be at first glance. Let’s take a look:
Opportunity cost
The most obvious reason why it is a bad idea to pull money out of your TSP is that you lose the gains the money would have generated had it remained diversified in the TSP. The mathematics of compounding interest can be powerful, given time, in growing your savings.
The TSP charges you the G fund rate at the time of your loan, which remains fixed. You pay this rate back to yourself. You do sacrifice the earnings you could have made if the money had remained in the account, invested in other than the G fund, and not been borrowed.
Immediate taxation
As you pay your loan back through payroll deductions, it is important to know this is after-tax money. For every dollar you borrow, you have to earn that dollar plus your effective tax rate, in order to satisfy the loan payment.
Double taxation
When you retire and are ready to make withdrawals from your TSP account, that money will be taxed at ordinary income tax rates. There is no distinction for the money you had previously paid back with after-tax funds. These funds will be taxed at your ordinary income rate.
In effect, a portion of your TSP account will have been taxed twice because of your loan; once during loan repayment and once during withdrawal of funds.
Stopping contributions
Those that borrow from their TSP accounts face the possibility of voluntarily reducing their regular TSP contributions. They may not be able to afford the loan payback schedule, along with continuing their regular TSP payroll deductions that have been taking place, so they cut back on TSP contributions. Therefore, the loan will cause them to reduce their long-term retirement savings. This could have a significant effect on their ability to retire on time.
In conclusion, the TSP loan program provides some access to your funds before you separate from the government. However, it can come at a steep price, particularly for those that are not fully informed on the costs, both hidden and apparent.
