Retirement with an Outstanding TSP Loan? Here’s What You Need to Know
The Thrift Savings Plan (TSP), a tax-deferred retirement savings and investment plan, offers Federal employees similar savings and tax benefits as 401(k) plans offered by private companies. Through the TSP, Federal employees save a portion of their income for retirement while receiving matching contributions and reducing taxes. While taking out a TSP loan, careful consideration should be taken with its potential effect on retirement income.
How a TSP Loan Works
With a TSP account, you can borrow from your own investment. The loan amount, however, cannot exceed the amount of your contributions and the earnings from those contributions. You also cannot borrow from contributions or earnings received from your agency or service.
If loan eligibility is met and the loan is approved, the loan amount is removed from your TSP account and must be repaid with interest. These loans are typically repaid through payroll deductions.
Types of TSP Loans
The two types of TSP loans that are allowed are General Purpose and Residential. The General Purpose loan can be used for any reason, requires no documentation, and has a repayment term of 1 to 5 years. A Residential loan must be used to buy or build a primary residence, requires documentation, and must be paid back within 15 years. TSP loans currently have a much lower interest rate than a commercial mortgage, student loan, or credit card.
Nearing Retirement With a TSP Loan
If you decide to retire before your loan is repaid, you can pay a little extra each month, use your tax refunds to pay a larger portion, or pay the balance in one lump sum. The TSP is required by law to report any unpaid loan balance as a taxable distribution. You’ll have a 90-day grace period to pay it off before this happens. If you can’t pay the remaining balance within this time period, both federal and state income tax will be owed at your regular rate on the outstanding balance and interest. You may also be subject to the IRS 10% early withdrawal penalty unless you turn 55 or older in the calendar year when you separate from federal service.
Use an IRA to Your Advantage
If any part of a TSP loan is associated with Roth contributions, those contributions will not be subject to tax. That’s because a Roth retirement account is for income that was already taxed before you contributed to the retirement account. You may, however, still owe a penalty if you’re under the age of 55. You can also move funds from your TSP to a different IRA to potentially buy a little extra time to pay off the loan. This is because you’ll have an additional 60 days from the time the taxable distribution is declared to complete the rollover and pay the loan amount into your IRA with other funds.
At Federal Educators, we can help you better navigate the complex TSP loan scenarios as well as your retirement benefits. Give us a call and request your free analysis at 866-226-8160.
