I have mixed feelings about TSP loans.
For some they can be a savings grace in a bind but they are often misused.
We all know that unexpected things happen in life and ideally none of us would ever have to touch our retirement savings to cover these emergencies.
But because life is often not ideal, there are certain times that a TSP loan might just be the best option even with the negative consequences.
One Last Check
Before truly considering a TSP loan, make sure to do one last check that you don’t have any other funds that you can use.
The TSP should be one of the very last places to go for money.
When money is taken out of the TSP it can no longer grow and compound over time which can severely lower what your TSP balance could be at retirement. Also, if a TSP loan is not fully paid back by the time you leave government service then it will be counted as a taxable distribution.
So you may not want to take a TSP loan if you are leaving government service in the near future.
Getting Money Out
There are 2 main ways of getting money out of your TSP while you are still working: A loan or an in-service withdrawal.
The downside of an in-service withdrawal is that it can be subject to taxes as well as a 10% penalty if you are under age 59 and ½. But of course you won’t need to pay the withdrawal back.
A TSP loan is often the better option because you won’t owe taxes or a penalty and you will get the money back into your account once you pay it back.
This chart shows a comparison between an in-service withdrawal and a TSP loan
|TSP Loan||In-Service Withdrawal|
|Cost||$50 Loan Fee||Your retirement savings will be permanently lower because of this withdrawal|
|Effect on Taxes||None (unless you leave service before it is paid back)||Can be subject to taxes and a 10% early withdrawal penalty if under 59 and 1/2|
The True Cost of a TSP Loan
But remember, the true cost of a TSP loan is not the $50 loan fee. It is the fact that the money that you take out of your TSP is not invested and can’t grow during that time.
This can make a significant difference over time.
Paying Off High-Interest Debt
The first situation that it may make sense to use a TSP loan is to pay off high-interest loans such as credit cards.
In many cases, credit card interest can be 15%-20% while the current interest rate on a TSP loan is 1.375% (as of 3/30/21). Not to mention that any interest that you do pay on a TSP loan just goes back into your account.
But like always, we will want to make sure that we are solving the underlying problem and not just fighting symptoms. If our spending habits keep putting us into credit card debt then pulling from your TSP will only be a short-term fix.
I would only consider using the TSP for debt when you are fully committed to not accumulating more credit card debt.
Medical Emergency With HDHP
A high deductible health plan or HDHP can be a great way to save money in premiums, but as the name suggests the deductibles are high.
This means that some people may be caught without the savings to cover the deductible when a medical event happens in their family.
The best way to pay the deductible in a high deductible plan is with an HSA or health savings account because of its great tax advantages. But for those that don’t have an HSA and don’t have the savings, a TSP loan may be the next best option so that they can preserve their credit.
Emergencies often occur when we least expect them and some people may be caught financially unprepared. This can be even more stressful if bad credit prevents you from getting a loan at a reasonable rate.
In these situations, it can sometimes make sense to access the TSP to avoid more high-interest debt.
But as always, we should always do whatever we can to not put ourselves in this position in the first place.
For those with good credit, a HELOC (home equity line of credit) may be a better alternative to a TSP loan.
As a general rule, I don’t recommend a TSP loan unless it is really needed but in some circumstances it can be a great tool to provide flexibility in tough times.