The TSP Loan
WHY THE TSP LOAN COULD BE YOUR BEST LIFELINE
- May 21, 2020
- 1:56 PM
Written By: Joseph Polakovic
A priority for many Americans today is to pay off their outstanding debts. This makes it very difficult to save for retirement at the same time. The common understanding of a retirement account seems to insinuate that those funds are not available until retirement. As such, many federal employees are electing to not make at least a 5% contribution and thus miss out on a portion or all of the government’s matching program. The significance of this could easily result in the need to work 5-10 more years before retiring. Not only is there less money going into the account but there is less match and less ability for compound growth. So, this truly is an exponential problem.
Taking a Lifeline
For those who find themselves in this situation of toxic debt, the TSP Loan could provide a much-needed lifeline. The TSP Loan allows you to borrow funds out of your TSP account and pay them back into the account over time at the G-Fund rate of interest. Where else can you find a personal loan for 0.750%? Best of all, the interest you pay goes directly back into your account. These loans come in two categories, general-purpose and residential loans. Here are the basic rules and facts:
Normal TSP General Loan Rules
You can access up to 50% of your TSP’s value or up to $50,000, whichever is smaller
For general purpose loan you have AT MOST 5 years to pay it back, residential can go up to 15 years
Payments come directly from your biweekly wages
This is NOT a distribution, so it’s not taxed or penalized
You do not need to be a certain age to access it
You can only have one loan outstanding from each category at a time
COVID-19 Temporary Rule Changes
You can access up to 100% of your TSP’s value or up to $100,000, whichever is smaller
You have 6 years to pay it back. This new law allows the borrower to suspend the obligation to make payments for 1 year. This allows up to 16 years for a residential loan
Payments come directly from your biweekly wages
This is NOT a distribution, so it’s not taxed or penalized
You do not need to be a certain age to access it
You can only have one loan outstanding from each category at a time
Have Your Cake and Eat It Too
Due to the fact that the government matching program is such a substantial part of a federal employee’s compensation and eventual retirement, it’s worth considering strategies that assist the federal employee to maintain at least a 5% contribution. The loan can give you the ability to keep up self contributions, obtain the full match, and keep investments growing (again, interest paid on the borrowed funds goes back into your own account).
This works as a wonderful tool to combat bad debt. For ease of explanation, let’s call bad debt anything that has a higher interest rate than what you can conservatively and reasonably expect to earn from your investments. Credit card debt almost always falls into this category.
At Retirement
One of the largest hesitations to using this loan is the potential impact on retirement. However, this is frequently misunderstood. You CAN retire with an outstanding TSP loan balance. Whatever is not paid back will count as a distribution to you, so be prepared to pay the tax on it. Like anything, this system can be abused and can get you into trouble. If you cannot repay the loan while working or you separate from service there WILL BE TAXES AND POSSIBLE PENALTIES.
The TSP Loan is widely underutilized in today’s financial planning. If you have a situation you’d like to discuss, schedule an appointment with us for your complimentary review!
Questions? Reach out to us at info@castlewestfinancial.com
