Borrowing From Your Thrift Savings Plan – Is it a Good Idea?

Many federal employees take advantage of the tax-free loan provisions of their Thrift Savings Plan to borrow money for a variety of reasons – and one very common reason is to put a down payment on a house. Is this a good idea?

Well, it can be a good move – interest rates on TSP loans are generally very favorable, compared to other sources of credit, such as bank loans and credit cards, most of the time. But as a veteran or member of the military, you fall into a different category from the typical garden-variety federal employee who has never served in the military. Specifically, as an honorably discharged veteran, you should qualify for a VA home loan, provided you have decent credit and an acceptable debt to income ratio.

How TSP Loans Work

Let’s take a look at the mechanics of the program: When you contribute to the TSP, Uncle Sam takes the money and sticks it in an account on your behalf before the money hits your paycheck. That means you haven’t paid taxes on the money yet, though you can see the accounting for it on your leave and earnings statement (LES). This is important to understand later.

Money in a TSP account grows tax-deferred. Normally, outside of a retirement account, you would have to pay income tax on interest, dividend income tax on dividends you receive from stocks, and capital gains tax on any profitable sales of assets. But none of that matters in your TSP. The account grows and grows until you take the money out – usually in retirement, at which time you have to pay the income tax rates then in effect, when you actually draw the money from your TSP account.

But you can borrow against your balance without taking the money out – technically. You are just taking out a loan, secured by the remainder of your TSP balance, and accepting the obligation to pay yourself back – with interest. The government will take the repayment amount directly from your paycheck, though. If you want to pay off the loan, just call the TSP for a payoff amount at any time, and send them a cashier’s check in the mail, or do an electronic transfer.

You only have a limited amount of time to pay back the loan, though. Any balances you keep as distributions – and you will pay income tax. Remember how you didn't pay income tax when you put the money in? Well, there’s no such thing as a free ride: You have to pay income taxes when you take the money out. Furthermore, if you are under age 59½ you will generally have to cough up a 10 percent additional penalty on the money.

The TSP administrators recognize two kinds of loans: Loans for a personal residence, which require documentation and which you can take up to 15 years to repay, on one hand, and general purpose loans. These loans don’t require documentation, but you must repay them within five years. In both cases, you have to start paying off the loan within 60 days of borrowing the money.

For more on this subject email me at dhatch@erashields.com