Should You Borrow From Your Thrift Savings Plan?

Careful: The Low Interest Rate Loan Can Lead to a Tax Bill

If you’re a federal employee looking for a low-cost way to borrow money for a home, to consolidate your other debt, or for another financial need, your thrift savings plan may be very appealing. A thrift savings plan is a retirement plan for Federal employees and members of the uniformed services. Each year, you can contribute up to the annual limit and earnings accumulate over time. Certain agency employers also match your contributions up to a certain limit.

Qualifying for a loan from your thrift savings plan is relatively easy and less expensive compared to most other types of loans. For example, the interest rate for TSP loans as of August 16, 2019 is 2.125%. Meanwhile, average mortgage rates are 3.60%; the average rate for a 60-month car loan is 4.61%; and the average credit card rate is 17.14%.

Borrowing from a TSP is also relatively easy compared to other forms of borrowing. Because you’re tapping into your own savings, there’s less paperwork, no credit qualifications, and the likelihood of being turned down for the loan is very low. You’ll typically qualify to borrow from your thrift savings plan as long as you’re a Federal Employee in pay status and you haven’t recently repaid another TSP loan or taken a taxable distribution from your savings plan.

You have two options for borrowing from your TSP. You borrow a General Purpose loan for most of your non-real estate financial needs. The General Purpose loan doesn’t require any additional documentation, but you do have to repay the loan within five years. If need to borrow from your TSP to purchase or construct a primary residence, the better option is to take out a Residential Loan. This type of TSP loan does require additional documentation and can be repaid in up to 15 years.

How Much Can You Borrow From a Thrift Savings Plan?

There’s a limit to the amount you can borrow from your thrift savings plan. Depending on the amount of financing you need, other forms of borrowing may be a better option. You can borrow between $1,000 and $50,000, but the maximum loan amount cannot exceed the amount you’ve contributed plus earnings on your contributions.

Your borrowing options may be limited if have another outstanding TSP loan of the same type you’re applying for, you’ve repaid a loan within the past 60 days, you’ve taken a taxable distribution within the past year, or you have a court order against your TSP.

The Downside of Borrowing From Your Thrift Savings Plan

While the ease and low cost of borrowing from a thrift savings plan can make it an attractive option, there are some downsides to consider. You won’t earn any interest on the outstanding loan amount, which will affect your long-term retirement savings. Instead of earning interest on your retirement savings, you’ll instead have to pay interest as you replace the funds you’ve borrowed. Your TSP loan is paid with your post-tax income via payroll deductions, so you lose some of the tax benefits of your initial pre-tax contribution. You’ll be taxed on the funds again when you withdraw it in retirement.

Repaying a TSP loan may affect your ability to make voluntary contributions to your plan, if you can’t afford to repay your loan and make contributions. Unfortunately, reducing your contributions will compound the growth of your retirement fund and could possibly delay your retirement age.

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, but there are still consequences. Because your contributions to a TSP were made pre-tax, you will be taxed if you fail to repay the loan. Your loan may be declared to be in default if you miss payments or you pay less than the amount due. Any amount you haven’t repaid by the end of the repayment period will be declared a taxable distribution and reported as income to the IRS.

If for some reason, you can’t repay your TSP loan, the unpaid amount will be treated as a taxable distribution from your retirement savings. At that point, you may be charged a 10% early withdrawal penalty if you are under age 59 ½. Failing to repay your TSP loan reduces your overall retirement savings amount, leaving you with fewer funds available when you’re ready to retire.

Making a Final Decision

If you can afford to continue voluntary contributions while you also repay your loan, you can offset some of the downsides of borrowing from your thrift savings plan. However, keep in mind that defaulting on your loan can derail your retirement and hit you in the wallet when it comes to taxes. 

Article Sources

  1. Thrift Savings Plan. "What Is the Thrift Savings Plan (TSP)?" Accessed Oct. 2, 2019.

  2. Thrift Savings Plan, "Current Limits and Rates," Accessed Oct. 2, 2019.

  3. Federal Reserve Bank of St. Louis. "30-Year Fixed Rate Mortgage Average in the United States," Accessed Oct. 2, 2019.

  4. "Average Car Loan Rates for October 2019," Accessed Oct. 2, 2019.

  5. The Federal Reserve. "Consumer Credit - G.19," Accessed Oct. 2, 2019.

  6. Thrift Savings Plan. "Summary of the Thrift Savings Plan," Page 16-17. Accessed Oct. 2, 2019.

  7. Thrift Savings Plan. "Loan Basics," Accessed Oct. 2, 2019.

  8. Thrift Savings Plan. "Choosing Between a TSP Loan and an In-Service Withdrawal," Accessed Oct. 2, 2019.

  9. Thrift Savings Plan. "Loans," Page 12. Accessed Oct. 2, 2019.