Like many 401(K)s, the Thrift Savings Plan (TSP) allows active participants to borrow from their accounts. However, before you can determine whether taking out a TSP loan is the right choice, you must understand how the TSP loan works. Read on for a quick review of the TSP loan nuts and bolts.
How A TSP Loan Works
When you take a TSP loan, you’re borrowing from your contributions to your TSP (agency contributions are not included). Once approved, the loan amount will be removed from your TSP proportionally from any traditional and Roth balances. Similarly, if your TSP is invested in more than one fund, your loan is deducted proportionally from each fund.
Loan Types & Terms
There are two types of TSP loans — general purpose and residential. The terms of the loans are one to five years and one to fifteen years, respectively. The general-purpose loan doesn’t require any additional documentation, but you must submit documentation to support the amount of a residential loan.
Note: If you leave federal service with an outstanding TSP loan, you’ll need to pay the entire outstanding balance back within 90 days. If you do not repay the loan within the required time frame, the TSP will declare a taxable distribution, meaning you will be liable for taxes and penalties.
The general eligibility requirements are as follows:
- Must have at least $1,000 of your own contributions and earnings in your account (agency/service contributions and earnings cannot be borrowed).
- Must not have any court orders against your TSP.
- Must be in “active-pay” status because repayments are set up as payroll deductions.
- At least 60 days must have passed from when you paid off your previous TSP loan (if any).
- Must be an active federal employee or a member of the uniformed services.
- At least 12 months must have passed from when you last took a taxable distribution from your TSP.
- You are limited to one outstanding general-purpose loan and one outstanding residential loan from any one TSP account at a time.
- If married, you must have spousal consent on the Loan Agreement.
In addition to the above requirements, residential TSP loans are limited to the purchase or construction of a primary residence, which may include any of the following:
- Shares in a cooperative housing corporation
- Mobile home
- Recreational vehicle
The minimum amount you can borrow with a TSP loan is $1,000. The following rules limit the maximum amount you can borrow:
- You can’t borrow more than you’ve contributed to the account, plus earnings.
- You can’t borrow more than 50% of your vested account balance or $10,000, whichever is greater.
- You can’t borrow more than $50,000 minus your highest outstanding loan balance, if any, during the last 12 months. For example, if you took out a loan for $25,000 and paid the loan back in full within 12 months, the maximum loan amount you would be eligible to borrow would be $25,000 ($50,000 minus $25,000, the highest outstanding balance during the last 12 months).
Taking out a TSP loan is essentially borrowing from yourself, yet there can be significant costs. The following are the costs associated with a TSP loan:
Loan Fee: The direct costs of a TSP loan include a loan fee of $50 deducted from your loan proceeds. So, if you take out a loan for $1,000, the amount paid to you will be $950.
Interest: In addition to the loan fee, you will be required to pay interest on your loan. The interest rate on your loan is fixed and is the G Fund rate when your loan application is processed.
Opportunity Cost: Although the interest you pay goes back into your account, it’s likely far less than what you could have earned by investing your money in a diversified TSP portfolio. Therefore, the missed growth opportunity is a significant cost you may bear when taking funds out of your TSP account.
Under the right conditions, the TSP loan can be an effective source of funding. However, before borrowing from your retirement account, you should consider the significant costs and potential tax consequences if you separate from federal service with an outstanding loan balance. Deciding whether a TSP loan is the right choice can be a complex decision and one that you will ideally seek the guidance of a qualified financial planner when making.