Don't Go Holiday Shopping With Your Thrift Savings Plan

By FINRA Investor Education Foundation Staff

When you're shopping for the holidays, it can be tempting to abandon your budget and buy more than you planned for your family and friends—or for yourself. But what happens when the credit card bills start coming in? Or you realize that you don't have enough cash to cover your everyday costs?

If you find yourself thinking about tapping your Thrift Savings Plan (TSP) for extra funds, you may want to think again. A retirement plan is where many Americans build their retirement nest egg, and that, of course, is the primary function of the TSP. But some retirement plans, including the TSP, allow participants to take out loans. While taking a loan may help solve an immediate financial need, there can be consequences that may reduce your long-term financial security. Here's what you should know before taking a loan from your TSP.

TSP Loan Basics

When you borrow from your TSP, it's like getting a loan from any financial institution. You sign a loan agreement that spells out the principal, the terms of the loan, the interest rate, any fees and other conditions that may apply. You may have to wait for the loan to be approved, though in most cases you'll qualify. After all, you're borrowing your own money. And, when it comes to making good on your loan payments, the TSP requires you to repay your loan through payroll deductions, which means you're unlikely to fall behind as long as you remain employed.

The IRS limits the maximum amount you can borrow from a retirement plan at the lesser of $50,000 or half the amount you have vested in the plan. The minimum loan amount required by TSP is $1,000.

The interest rate you will pay is based upon the Government Securities Investment Fund (G Fund) rate when your loan is processed. That rate will remain in effect for the life of the loan.

TSP loans have a one- to five-year term. The exception is if you use the loan proceeds to buy a primary residence—the home you'll be living in full time. In that case, the TSP allows up to a 15-year loan term.

So what happens to your TSP investments when you take out a loan? The money usually comes out of your account balance. In many plans, the money is taken in equal portions from each of the different investments in your account. For instance, if you have money in four mutual funds, 25 percent of the loan total comes from each of the funds.

The TSP permits you to designate which investments you'd prefer to tap to put together the total loan amount.

Pros and Cons of TSP Loans

Before you borrow from your TSP, consider the following.

On the plus side:

  • You usually don't have to explain why you need the money or how you intend to spend it.
  • The interest you pay is paid into your TSP.
  • There is no income tax or potential early withdrawal penalty, since you're borrowing rather than withdrawing the money.

On the negative side:

  • The money you withdraw will not grow if it's not invested.
  • You repay the loan with after-tax dollars that will be taxed again when you eventually withdraw them from your TSP, so you are paying double taxes to get the benefit of the loan funds.
  • The $50 fee you pay to administer the loan will be deducted from the amount you borrow.
  • The interest on the loan is not deductible, even if you use the money to buy or renovate your home.

Beware of the Risks

The biggest risk you likely face with a TSP loan is separating from the service while you have an outstanding loan balance. If that's the case, you'll probably have to repay the entire balance within 90 days of separation. If you don't repay it, you'll be in default, and the remaining loan balance is considered a withdrawal. You'll also owe income tax, and possibly a 10 percent penalty, on the unpaid amount. So you could find your retirement savings substantially drained and your long-term financial goals in jeopardy.

For more information on managing and investing in the TSP account, visit FINRA's 401(k) Learning Center and the TSP web site.

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