The Truth About TSP Loans, And When They Make Sense

What Is a TSP Loan?

A TSP loan is similar to a 401(k) loan—which lets you draw money against your retirement account—but designed specifically for federal employees. However, there are multiple types of TSP loans, including:

  • Residential TSP loans. You can use these to help pay for building or buying your primary residence. TSP states this can include homes, condos and even RVs or boats. You aren’t able to use residential TSP loans for refinancing, remodels or buying land by itself, although you could use a general TSP loan for these things. Term lengths range from one to 15 years.
  • General TSP loans. These are much like personal loans, and you can use them for just about anything. Term lengths range from one to five years.

Video

How do TSP loans work?

With a TSP loan, you are essentially borrowing your own money with a specified period of time to pay it back. The TSP loan rate charged will be equivalent to the G Fund rate (Government Securities Investment Fund) in the month your loan was approved.

Much like a 401(k) loan, when you pay interest charges on a TSP loan, you’re paying them to yourself instead of to a bank or lending institution because all of the money repaid goes back into your retirement account.

Interest Rate

The loan interest rate for the life of the loan will be the G fund’s interest rate that is in effect on the date that the TSP loan agreement is generated.

Will a TSP Loan Affect Your Credit?

Because you’re technically borrowing your own money, taking out a thrift savings plan loan doesn’t require a credit check. That means you can avoid a ding to your credit score that’s caused when you apply for other loans. Repaying your TSP loan also won’t help or hurt your credit score because your payment history isn’t reported to any of the three major credit bureaus.

Defaulting on your TSP loan won’t hurt your credit score, either, but there are still consequences. Because any unpaid amount will be treated as a taxable distribution from your retirement savings, you may be charged a 10% early withdrawal penalty if you are under age 59 ½.

Should you get a TSP loan?

Compared with other types of loans, TSP loans are fairly low risk — interest rates are low, and you’re borrowing from yourself rather than from a lender. If you need to borrow money for a purchase that you can’t afford out of pocket, a TSP loan is a good solution.

However, it’s also important to consider the costs and rules associated with TSP loans before you apply:

  • There is a $50 processing fee per loan, which will be deducted from the loan amount.
  • Most TSP loan borrowers will incur indirect costs in the form of sacrificed earnings because the money you borrow for your loan won’t have a chance to accrue interest. Even though you’ll be paying interest back to yourself, that amount is often less than what you would have earned if the money had remained in your TSP account.
  • When you pay interest back to yourself, you are doing so with after-tax dollars. This means that when you begin receiving disbursements from the account upon retirement, you will pay taxes again on the same funds.

You’ll also want to ensure that you can afford to repay the monthly TSP loan payments. Use the Thrift Savings Plan loan payments calculator to find out how much you can expect to pay each month.

Disadvantages of a TSP loan

Although borrowing against your own savings is a low-risk way of securing funds, it’s not always ideal.

For example, unlike other borrowing options, like a traditional personal loan, TSP loans won’t help you build or improve your credit since payments aren’t reported to the credit bureaus. TSP loan funds might be taxed as income twice, as mentioned above — once for the loan and again upon disbursement later in retirement.

Finally, a significant risk is if you leave your federal job with an outstanding loan. In this situation, you’ll either have to pay it back in one lump payment or otherwise face default, which can lead to other tax- and credit-related complications.

Cons of utilizing the TSP Loan

Here is where I attempt the difficult task of ruining this loan for you despite all of the above reasons it is a great loan product. The problem is that most of the reasons this isn’t great are intangible…but trust me, they can be catastrophic.

Tax Implications if You’re Borrowing from the Traditional TSP

A commonly overlooked issue with the TSP loan is the additional taxes you’ll be paying on that money. Consequently, this is the one tangible reason that a TSP loan is not the best way to borrow money.

Who Doesn’t Love Being Taxed Multiple Times?

When you contribute to the Traditional TSP you are contributing Pre-Tax dollars. However, when you are repaying the TSP loan you will be doing so with post-tax dollars. That erases the entire benefit of the traditional TSP in the first place!

To make matters even worse, because the traditional TSP is taxed on the back end, and contributed to with pre-tax dollars you will be taxed twice on the money that you borrowed.

Think about it, if you repay the loan with post-tax dollars (meaning you already paid taxes once) and the traditional TSP is taxed at withdrawal…you’ll be paying taxes a second time on that money now, which is not cool!

Taxable Event if You Fail to Repay the TSP Loan

Here’s another fun con, if you fail to repay your loan the IRS will view the loan as a taxable withdrawal of funds. You will be assessed an instant 10% penalty in taxes that you owe the IRS!

Talk about a “fun” bonus to have your loan costs suddenly jump 10% immediately!

Opportunity cost

Let me paint a picture for you; Let’s say you took a loan for $10,000 in January of 2021, and let’s assume the interest rate was an easy 2%, and you repaid it in full in exactly 12 months.

In the above scenario, you would have paid $200 in interest, for a total of $10,200 paid back to yourself.

Now, what if I told you that money could have earned over 40% ROI if you had just left it in the TSP? I know this sounds crazy, but my personal TSP returns for 2021 were 44.61%!

In this scenario, your account would have grown by $4,000.

By taking the TSP loan your balance at the end of January 2022 (12 months from loan inception) would be $10,200 instead of $14,000—The TSP Loan actually cost you 38% in opportunity cost.

Now, obviously, the argument is “Well Dave, what if the market goes down while I have the loan out” and you’re correct. However, markets generally trend up over time, and attempting to time the market is a losing game.

Ultimately, you need to understand that there is a good chance the TSP loan will cost you a lot more than the interest rate you’re repaying.

Risk of Ruin

I view my Thrift Savings Plan as my “super-duper emergency fund” that I will only touch in a worst-case scenario. For example, in March of 2020 when COVID first started to wreak havoc on landlords I was able to look at the balance of my TSP and say “well, worst case scenario I have enough money in there to pay all of my mortgages for 18 months even if my tenants don’t pay me a penny”.

In my opinion, you can’t put a price on that security, and you lose that if you borrow from the balance.

Also, the TSP is your retirement fund. You’re borrowing from your future self in order to fund your current lifestyle. You need to make absolutely certain that you’re not assuming a risk that could wipe out your loan amount and harm your future self.

Never assume the risk of ruin!

Con: Short Loan Terms

Typically, another disadvantage of getting a TSP loan is that the term lengths are usually 15 years or less to repay them. On larger loans of say $50,000, this can make the payments relatively high and take a big chunk out of your monthly budget to live. 

TSP Loan Downsides

As the COVID-19 pandemic rolls on, you might need to make ends meet by borrowing from your future self. Again, in normal circumstances we would strongly advise against taking money out of your retirement fund to cover current costs, but these times aren’t normal. 

As you think about a TSP loan, remember that your future self is losing potential earnings as repayments are taken out of your paychecks.

“The money you borrow misses out on the potential for growth in the stock market until it’s repaid,” Taylor says. “Payroll deductions that previously went to building your account value instead go toward loan repayment until your TSP loan is paid off, which also slows progress towards retirement.”

Also keep in mind the limitations on how much you can borrow. The maximum amount is $50,000, so if you need more than that, you may need to consider alternatives, like a personal loan or home equity loan, if possible.

Con: Application Fee

A disadvantage over many other loans is that they charge a $50 application processing fee directly out of your loan funds when you get your loan funds. Many other lenders do not charge a processing fee for taking your application for a loan.

TSP Loan Reason #2:  The borrower believes they have a better use for the money

For purposes of this article, we’re going to skip a lot of discussion about investment philosophy, risk, etc.  We’re going to focus on the use of TSP as a tax-deferred savings vehicle.  We’ll compare this to some commonly identified uses of TSP loan proceeds (commonly identified as being what pops up on the first 3 pages of Google Search Results for ‘investing TSP loan’).  Here’s what I found:

Using a TSP Loan to Buy a Rental Property (Bigger Pockets.com).  Oh boy.  We can go down a rabbit hole here.  However, let’s say that you’re a first time rental owner.  Before we determine whether a TSP loan makes sense, it’s important to actually make sure the purchase makes sense.  After all, if you’re not ready to be a landlord, then it doesn’t matter where the money comes from.

Let’s assume you’ve run the numbers & run the scenario by all the real estate landlording mentors that you know.  They all agree:  this purchase is a good investment.  If that’s the case, a bank would probably be willing to finance the purchase.  After all, a good deal means that the rental income will be more than enough to make up for all the hiccups that come along the way.  And if a bank thinks it’s worth financing, then why would you use your own money to finance the deal in the first place?  One of the benefits of real estate investing is the appropriate use of leverage.

If you keep getting turned down by the bank, then maybe the property isn’t a good deal after all.  In that case, maybe you shouldn’t a TSP loan on such a risky investment.  And if you can get a bank to finance the deal, then you can keep your money growing in your TSP account on a tax-deferred basis.

Can I use TSP to invest in gold or other precious metals? (mentioned on Zacks.com – but it’s such a bad idea we’re not going to link to it)

Sure.  You can take the loan and invest in gold, lottery tickets, tulips, or whatever you want.  However, when investing in gold, it’s important to remember a couple of things:

  1. Tax treatment. Gold is taxed as a collectible.  Since gold doesn’t pay interest or dividends, the only money you make is when you sell (assuming you sell at a profit).  Collectibles are taxed at a maximum tax rate of 28%.  This is significantly more than long-term capital gains.  Long-term capital gains are subject to a max of 20%.  And forget about the tax deferred treatment…that only exists inside the retirement plan.  After-tax treatment applies to TSP loan proceeds invested outside the plan.
  2. Liquidity.  You can sell gold relatively quickly.  In a worst case scenario, a pawn shop will give you money much faster than you can sell a house.  However, the liquidity question is, “How much value does it retain if I have to sell it quickly?”  The immediate value of those gold coins that William Devane sold you is the market price of their weight.  That’s it.  It doesn’t matter if it’s a collectible set of coins with Thomas Jefferson, baby seals, or Thomas Jefferson clubbing baby seals, you’re probably going to get less than you paid for it.

If you weren’t inclined to take a bunch of money and buy gold with it, it’s probably not a good idea to take out a TSP loan.

Taking out a TSP loan to fund Roth IRA (Bogleheads.com)

On the face of it, this seems like a pretty good idea.  After all, you’re taking a bunch of tax-deferred money, then using it to fund a Roth IRA, which is tax-free.  Here are a couple of considerations:

1. Why wasn’t a Roth part of your investing approach in the first place? After all, TSP accounts don’t grow that large overnight.  If you’re making a sudden change just because you want money in your Roth account, you might want to consider why.  After all, you’re going to repay that loan with after-tax dollars, so the net result will be fairly similar as if you just started contributing to the Roth IRA in the first place.

However, if you’re in a higher tax bracket, then foregoing the tax deferral on future TSP contributions (because you’re repaying your TSP account with after-tax dollars) doesn’t make sense.  You’re essentially giving away your tax benefit by using after-tax money to reimburse yourself.  Just use the after-tax contributions to fund your Roth IRA and leave your TSP to grow tax-deferred.

Conversely, if you’re in a lower tax bracket, then you might be better off doing a Roth conversion.  If you’ve got a ways to go before separation or retirement, you might consider doing so from a traditional IRA.  If you’ve got a lot of cash flow, then max out Roth TSP and a Roth IRA for both you and your spouse.

2. What are you going to invest in with the Roth IRA that you can’t do inside TSP? Before going any further, it’s best to understand what you are going to invest in.  If you’re looking to diversify your portfolio, you might want to make sure you understand what you’re going to diversify into.  That way, you’re not just paying more money to invest in bunch of index funds that do the same thing that TSP does.

However, this particular thread is interesting because of the ‘unique’ situation this person is in:

Due to some unanticipated expenses it is doubtful that my wife and I will be able to max out both our traditional 401ks and Roth IRAs. I place a higher value on fully funding the Roth since we plan to retire by the age of 50 and know that we can withdrawal our contributions without penalty until we hit 59.5. With that said, I want to continue to max out our 401ks because tax advantaged space should not be left on the table.

My thought is to take out a 1 year $11,000 TSP loan at 2% towards the end of the year to fully fund our Roth IRA while still maxing out our 2015 401k tax advantaged space.

The alternatives are to keep the money in the 401k and forfeit funding the Roth IRA this year or to significantly reduce our current TSP/401k contributions and fail to max out this year. Please explain how either of those options is preferable to my proposal.

In other words, I don’t have enough cash flow to max out my contributions this year.  I want to have my cake and eat it too.  If that’s the case, then I wonder several things:

  1. Will these expenses disappear between now and next year?   If this couple had been dutifully maxing out both accounts, and there was an emergent one-time expense, this might make sense.  However, they would have to have the cash flow to pay off the TSP loan and max out their investments next year.
  2. Is it possible to fund their Roth IRAs next year? The deadline for Roth IRA contribution is actually the tax return due date.  For 2017, the Roth IRA contribution deadline is April 17, 2018 (tax day falls on the next business day after weekends and holidays).  If this couple is so cash flow positive, I’d rather see them use the first four months of the next year to fund their current year Roth IRA, then max out the following year’s contribution.

However, you can’t use TSP loan proceeds to exceed the Internal Revenue Code’s IRA contribution limits.  Essentially, if you have the cash flow to max out all your contributions, you could take a TSP loan, then repay it back.  But you’d have to put the TSP loan proceeds into an after-tax account.  In that case, you’d be putting the loan proceeds into a taxable account, at the expense of your tax-deferred savings vehicle.  That doesn’t make sense, either.

I might take a $30,000 401k loan just to piss some of you off (PunchDebtintheFace.com).  This is pretty funny, and actually appeared higher on Google rankings than the previous two.  I kept it for last simply for the humor value.

While I might not agree with the fundamentals in this article, this person seems to have enough money set aside to afford repaying the loan.  His true question seems to be, “What is wrong with taking a 401(k) loan (or TSP loan, which he actually references in the article), then paying yourself the interest?

I’d say nothing is wrong, if that’s your fundamental approach.  But then, why would you go through the trouble of doing that when the net effect is the same as taking $30,000 in your TSP and putting it into the G-fund?  Either:

  • You weren’t going to invest that much money in the G-fund as part of your allocation strategy. In that case, borrowing it just to pay yourself back at the G-fund rate doesn’t make sense.
  • You were going to invest that much money in the G-fund as part of your strategy. In this scenario, it would be simpler to just keep the money in your TSP and invest that much in the G-fund.

Additional Thrift Savings Plan Articles

How to invest in the Thrift Savings Plan

Advanced TSP Strategies That Will Make You Rich

Avoid These 7 Thrift Savings Plan Mistakes

Tags