Retiring With an Unpaid TSP Loan? Here’s What You Need to Know

How can an outstanding TSP loan impact your retirement?

If you’re a federal employee or member of the armed forces, your retirement options are slightly different than those of your friends and neighbors in the private sector, but just like anyone else, it pays to plan ahead and know the rules when it comes to your retirement.

If you’ve invested in a Thrift Savings Plan (TSP) for your retirement, you’ve hopefully been investing as much as you can throughout your career — ideally maxing it out, but at least contributing 5% of your salary to take full advantage of the government’s matching funds.

But it’s not quite time to pat yourself on the back yet. If you’re nearing retirement age, you still have significant planning to do. One potential pitfall for TSP investors? An unpaid TSP loan.

What Is a TSP Loan?

When you have a TSP account, you are allowed to take out a loan against your own investment. This is similar to borrowing against a 401(k) plan in the private sector.

There are two types of TSP loans: General Purpose and Residential.

A General Purpose loan can be used for any reason and must be paid back within 5 years. A Residential loan must be used to buy or build a primary residence (i.e. your main home rather than a vacation home) and must be paid back within 15 years.

TSP loans are attractive because they currently have a much lower interest rate than a commercial mortgage, student loan, or other financing — and a very much lower interest rate than a credit card. They’re also convenient because you’ll repay the loan with payroll deductions that come directly out of your paycheck, so you never have to worry about missing a payment.

Heading Into Retirement With a TSP Loan

If you are nearing retirement age and are still paying off a TSP loan, you need to do some additional planning. If possible, it’s best to pay your loan off before retirement age.

If you’d like to retire before your loan is knocked out, you can make additional payments by sending a check in the mail along with a loan payment coupon. You can pay a little extra each month, use your tax refunds to give yourself a boost, or pay the balance in one lump sum if you can afford it. 

If you aren’t able to pay your loan down early, don’t worry: you can still retire with an outstanding TSP loan. No one will force you to continue working until it’s paid off.

However, there are some drawbacks to be aware of if your loan is unpaid at the date of your retirement. 

The TSP is required by law to report any unpaid loan balance — for both General Purpose and Residential loans — as a taxable distribution. You have a 90-day grace period to pay it off before this happens.

If you can’t pay the remaining balance by then, you will owe income taxes — both federal and state — at your regular rate on the outstanding balance and interest. Depending on the size of your balance, this could be a sizable tax trap that eats up your refund and could even leave you owing a big chunk of change come April. 

Also, you may be subject to the IRS 10% early withdrawal penalty, unless you turn 55 or older in the calendar year in which you separate from federal service. 

Some Silver Linings and Additional Details 

If your TSP loan was made against a Roth account, you may not have to pay income taxes on some or all of the unpaid loan amount — though you may still owe a penalty if you are under the age of 55. That’s because a Roth retirement account is for income that was already taxed before you contributed to the retirement account. You cannot be double taxed on this income. 

If some of your TSP contributions are traditional and some are Roth, the tax calculations become complex quickly. A good financial advisor will help you make the calculations and sort out the details so you can avoid costly errors on your tax filing the year you retire.

You can also move funds from your TSP to a different IRA if you wish. To do this, you’ll still need to pay the loan off — but you may be able to buy a little extra time to do so. That’s because you have an additional 60 days from the time the taxable distribution is declared (i.e., at the end of the 90-day grace period) to complete the rollover and pay the loan amount into your IRA with other funds. 

It’s important to note that these funds must have already been taxed, so you can’t just create a revolving door of rollover funds from various IRAs to get the job done.

About the Author

Neal Thompson is the founder of Federal Retirement Services and is recognized as one of the premier retirement planning advisors for federal employees. He has conducted countless retirement training workshops to help federal workers covered by CSRS or FERS get the most out of their retirement.