Rich on Money

Should I Get a TSP Loan?

It is possible to get a TSP Loan.

But should you?

  • Couldn’t we use it to buy real estate and make a fortune?
  • Couldn’t we invest in the next hot thing, like an IPO, or bitcoin?
  • What about gold!?!

These are some of the questions we are here to answer today.  I’ve heard people suggest these very things.

I’m going to first explain how the program works, then explore how using it will impact your future retirement income (ouch). 

If you want the BLUF (Bottom Line Up Front) and skip the TSP Loan intro, click this section , just tell me if I should get it or not!

THE TSP LOAN PROGRAM

I’ll be abbreviating the TSP loan program here, but here is the source link from tsp.gov.

The TSP Loan program lets you borrow money from your own TSP account while you are either in the armed forces or employed by the federal government. 

HOW IT WORKS

When you borrow the money, it comes out of your actual TSP account.  It can be any amount between $1,000 and $50,000, not to exceed your contributions and earnings from those contributions.  It does not include any agency contributions (blended retirement system or BRS) or earnings from agency contributions. 

As you are repaying this loan, it is repaid with interest through payroll deductions back into your own TSP account.  This means that this large amount of money will not be growing tax advantaged in your TSP account during the time period you have borrowed it.  You lose the opportunity for that growth.  More on this later.

Keep in mind, even though you are paying interest, it’s a low, low rate and you pay it back to yourself, so it’s not really a cost to you.  The interest, however, is not tax-deductible.

LOAN ELIGIBILITY

To be eligible for a TSP loan, the following must apply:

  • Employed by uniformed services or federal government
  • In pay status
  • Only have one outstanding general purpose loan and one outstanding residential loan from any one TSP account at a time
  • Have at least $1,000 in your TSP account not counting agency contributions and earnings
  • Have not repaid a TSP loan of the same type within the past 60 days
  • Not had a taxable distribution of a loan within the past 12 months unless it was the result of your separation from Federal service
  • Not had a court order against your TSP account

LOAN TYPES

RESIDENTIAL

  • Only used for purchasing or construction of primary residence
  • Repayment term is 1 to 15 years

You may be surprised what you can get away with calling a primary residence.

A boat or recreational vehicle will qualify.

tsp loan
I’m on a boat!

Residential loans cannot be used for the following:

  • Refinancing or prepaying an existing mortgage
  • Construction of an addition to an existing residence
  • Renovations to an existing residence
  • Buying out another person’s share in the borrower’s current residence
  • The purchase of land only

GENERAL PURPOSE

  • May be used for any purpose without restrictions
  • Has a repayment term of 1 to 5 years

The above restrictions on residential TSP loans are important, because if you wanted to do any of those things, you would be forced to use the general purpose loan.  This loan has a much more restrictive payback period.

LOAN AMOUNTS

The minimum loan amount is $1,000

The maximum loan amount is the smallest of the following scenarios:

  • Your own contributions plus earnings minus any loan balance
  • 50% of your vested account balance or $10,000, whichever is greater, minus any loan balance
  • $50,000 minus your highest outstanding loan balance

If you want to calculate your expected payment on a TSP loan, access this TSP online calculator

LOAN COSTS

The loans don’t cost much.  Cheap.

Loan Fee.  There is a loan fee of $50.  If you get a loan for $1000, the amount paid to you will be $950.

Interest.  The interest rate on the loan is the G Fund rate at the time the loan application is processed.  This rate is fixed for the duration of the loan.  All the interest goes back into your account, but the interest is not tax-deductible.

As of April, 2019, the TSP G fund interest rate is 2.5%.

Opportunity cost.  We will talk about this more later, but there are sacrificed earnings involved here.   The money that wasn’t invested, and wasn’t growing in a tax advantaged account, is something you have to calculate.  Is what you did with this money worth that opportunity cost?

That’s a tough call.  It’s impossible to know what the future holds as how your investments could perform.

TAX IMPLICATIONS TO CONSIDER

When you borrow money from your TSP account, you may face tax penalties.  This is because there may be two different types of contributions inside your TSP, traditional TSP, and Roth TSP contributions. 

Traditional includes contributions you and your employer have made that were not taxed.  Roth includes your contributions that already have been taxed, but also include earnings which will be taxed as income and subject to an early withdrawal penalty if you’re younger than 59 ½ years old.

The amount you borrow is taken proportionally from each pool, and if some of that income is subject to federal income tax, a percentage will be withheld to cover it.  Nothing is withheld for state taxes, you have to cover that yourself.  This is complicated, so make sure you consult a smart tax attorney.

Also, be sure to consult the Tax Treatment for TSP Payments Chart at the TSP website.

SHOULD YOU TAKE A TSP LOAN?

ADVANTAGES OF USING A TSP LOAN

  • You are paying interest to yourself, so the loan is free to you, outside of the nominal $50 administrative fee.
  • You avoid the 10% penalty on early withdrawal from retirement accounts.  If you weren’t 59 ½ years old yet, or hadn’t separated from federal service, you would’ve got stuck with this penalty. 
  • Interest rates are competitive (and they are paid to you)
  • No negative impact on your credit score.  It does not appear on your credit report, because you are taking a loan from yourself.  If you default on the loan, the unpaid balance becomes a distribution from your TSP account for which a 10% penalty and income taxes must be paid, but it will not show up on your credit report as a default.
  • Easy to qualify

DISADVANTAGES OF TAKING A TSP LOAN

  • When you borrow with traditional dollars, or pre-tax dollars from your TSP, you have to pay yourself back with after-tax dollars.  This means to pay back $1000, you have to earn $1320 at the 32% tax bracket.  Yikes!
  • When you borrow money from your TSP, you lose all the awesome tax advantaged and compounding benefits of that growth for the time period that money is not in your account.  This is one of the large opportunity costs of borrowing.  If it happens to be a high growth period, that could be huge.  In a bear market, you may jump for joy.  It is a huge risk to take.  You need to calculate how likely it is that whatever you did with the money instead could make you more money than had you left this money invested in TSP with the tax benefits and compound growth.
  • You might leave federal service either for planned or unplanned reasons, which would trigger the loan becoming due in 90 days.  Any unpaid balance will be reported as a taxable distribution, which brings us to the next disadvantage
  • Potential tax penalty.  If you for some reason fail to pay off a TSP loan or end up with a taxable distribution for any reason, an additional IRS early withdrawal penalty of 10% will be applied to the account if you are not yet 59.5 years old.  On top of that, you still owe taxes on the money.  The tax man cometh!

USING A TSP LOAN FOR REAL ESTATE

By the way, I would offer the exact same advice for a 401k loan, which is extremely similar in nature.

I have seen advice in the military community advocating for the use of TSP loans to assist in the purchase of investment real estate.  I’ve heard some so-called guru’s state that if a military member doesn’t have enough money for a down payment on a property, suggesting using a TSP loan as a way to invest in real estate to make better returns than would be possible in the TSP account.

This advice should not apply across the board to all military members.  It would be a rare case indeed where I think someone would have the education, experience, and understand the risks behind withdrawing money from their TSP to invest in real estate.   In no case do I believe it’s a wise decision.

First, I feel that taking money out of your tax advantaged TSP account to venture into unchartered waters for a first-time investment into real estate ventures (which is tricky) could be a recipe for disaster. Proceed with extreme caution and make sure you and the person you are working with really know what you are both doing.

Also, consider the motivations of the person who is asking you to pull money out of your TSP or 401k.  Do they need your money to finance one of their deals?  Are they getting a commission or fees out of this?  Ask a lot of questions.  Also, ask me.  I’ll be happy to be a sounding board.

Second, while many of you know that I am an avid real estate investor, I wouldn’t go so far as to say liquidate everything in your TSP and move it to real estate now.

I think that everyone should have a fully maxed out TSP and IRAs for themselves and their spouses (if applicable).  Once these tax advantaged retirement funds are maxed out, then and only then do I recommend considering having real estate investments.

Read How to Invest Your Money and Retire Early

TSP accounts are supposed to be for your retirement and should be sacred and not used as an entrepreneur fund.  Ventures into real estate are riskier than investing long term for retirement (like in broad based index funds). Proceed with caution.

Read The 10 Cheapest Index Fund to Supercharge Your Portfolio

Some people talk about tapping into your TSP if you can’t come up with a downpayment for your home and you want to avoid private mortgage insurance (PMI).  My answer to you is this:

If you don’t have enough money for a downpayment, then don’t buy yet.  Keep renting.  Buying primary residences are overrated anyway.

For these reasons, I caution you not to take out TSP loans for real estate.  If you don’t have the money to purchase real estate yet, then find some other way of making it work.  Save it up, get creative with financing, use another program. 

Maybe use your grandmother’s IRA (I’m kidding).

The TSP, as well as 401ks, should be left alone IMHO.

Read my articles on How to Get a VA Loan and How to Invest with VA Loans

PAYING OFF HIGH INTEREST CREDIT CARDS, STUDENT LOANS, OTHER DEBT

I’ve heard this advice as well.  You can use this wonderful TSP loan benefit to get rid of your high interest credit card debt that you got yourself into.  It can be tempting.  Credit card debt can be crippling, and very high, with interest rates as high as 15% or even higher than 20%, you can really get yourself into a hole. 

Right now, paying that off at a rate of 2.5% would seem like a no brainer, but here’s a couple of problems.

There is a psychological problem with letting yourself get to the point of having that high credit card debt, and another psychological problem with letting you rob your TSP or 401k to fix the problem.  If you rob it once, you’ll rob it again.  You are likely to charge yourself back into the same mess thinking you’ll TSP loan your way out of this problem next time.

That’s a bad habit to start.

My advice is, just like the housing issue above, the TSP is sacred.  Do not touch it for anything other than dire emergencies.  Get yourself out of your credit card debt the old fashioned way.  Stop buying shit you don’t need, and pay it off yourself.  Find ways to make more money, cut expenses, live more frugally.

BITCOIN AND IPOs

I’m not going to dignify this with a response.

CONCLUSION

I listed the advantages and disadvantages of using the TSP loan above. 

If you leave me a comment asking me if you should do it or not, I’m going to lean towards not doing it.  Find another way.  The TSP should be sacred.  That money needs to compound tax-advantaged for your retirement.  Don’t take a huge chunk out and miss out on that growth.

I think it’s an opportunity to get at some money when no other opportunity may exist. You need to understand what the cost of using that money is. 

The costs are high.

I always thought of TSP like an IRA or a 401k account.  It’s a legal way to cheat on taxes, limited to a certain amount of money.

I want to maximize the amount I can advantage of that, because taxes suck!

Don’t cheat yourself of money you could have in the future, because you think you need something now.  Try to find another way to fund whatever it is you’re trying to do.

It might be that you do the math and calculate the risk, and it makes perfect sense to take the loan.  Ok then.  Do it.  As long as you understand all the facts.

I’m not the first military blogger to write about this important topic. Here are two more great articles on this subject.

The Military Wallet

TSP Allocation

I’m ready for it.  Leave questions and comments.  Let’s hear it.

Rich on Money

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2 Comments

  1. I did use my TSP to secure my primary resident because i wanted to get 20% down ~ $160,000 to avoid PMI and lower mortgage payment and I wanted to preserve some cash for a follow-on renovation project. At the time, spring 2017, the market was up and I viewed it as taking some profit. As it is, I lost the opportunity cost of a continued up-market, but am pleased that I preserved cash with a 2.25% loan. I also knew it would be a short-term loan ~ 5 years due to retirement. Good thoughts, perhaps I will create a table that shows the actual opportunity cost based on varying S&P 500 returns and amounts borrowed. Thanks for your website!

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