TSP loans can be really helpful in a pinch and many federal employees end up using one at some point. But what impact do they have on your retirement? Is it as bad as people say?
The Nitty Gritty
To understand the impact of TSP loans we have to understand TSP loan basics.
How a TSP Loan Works
A TSP loan is when you take money out of your TSP and then pay yourself back over time from your paychecks. You do pay interest on the loan but you are paying the interest to yourself back into your TSP.
The minimum loan amount is $1,000. The maximum loan amount is 50% of what you’ve personally contributed into the TSP or $10,000 whoever is greater but this caps at $50,000.
The Two Types of TSP Loans
There are two different types of TSP loans: general purpose and primary residence.
The general purpose loan can be used for anything and needs to be paid back between 12-60 months (1-5 years).
There is a $50 processing fee for this type of loan.
The primary residence loan can only be used for the construction/purchase of a primary residence and they require documentation.
You have 61-180 months (5-15 years) to pay it back and it has a processing fee of $100.
What If It’s Not Paid Off By Retirement?
If you haven’t paid off the loan by retirement there are two options:
- You can make monthly payments in retirement
- You can let it lapse and your loan balance will be treated as a TSP withdrawal which could cause taxes and an early withdrawal penalty
The True Cost of a TSP Loan
While the processing fee will only be $50 or $100, the true cost of a TSP loan is often much higher.
While your money is out on loan to you it is not in your TSP growing. For example, if you took out $30k for 5 years it might’ve grown to $50k had it been left in the TSP. This means that that TSP loan cost $50 in processing fees and $20,000 in lost growth!
And while I hate the fact that the money isn’t growing in your TSP, sometimes it is the best option.
For example, if an emergency comes up and you can either take a TSP loan or be forced to put the expense on Credit Cards at 20% or a personal loan at 12%, then a TSP loan is probably the best option.
But ideally, we all have some sort of emergency fund to be able to help in these sorts of situations.
So while taking a TSP loan isn’t the end of the world, it certainly isn’t ideal either. It is best practice to manage your finances so you can leave your TSP alone to grow for your retirement.