Taking a loan against your TSP has become a common practice with federal employees. Even federal employees with high incomes have taken money out of their TSP because they felt it was a “good deal.” As many of us have seen in life, just because it sounds like a good deal does not mean that it is. Despite sounding like a great opportunity to gain access to your money, I would like to offer four reasons as to why TSP loans are not a good deal and why you shouldn’t take one.
1. You aren’t earning anything on your loan balance.
If we look at historical averages, the stock market makes money more often than not. With that being said, when you take a loan out of TSP, you are not earning anything on the amount of the loan. For example, if you take a $20,000 loan and the market is up 10% over the next year, you just missed out on a gain of $2,000. It is also important to point out that the extra $2,000 would have generated more money (due to compounding) for the duration of the investment.
2. You are taxed twice on the amount of the interest.
Who enjoys paying more taxes than they have to? I can’t say that I know of anyone. If you prefer not to pay taxes twice on your income, I would suggest not taking a TSP loan. When you pay the interest back, you are making payments with after tax dollars, which means that you paid taxes on the interest that you are now paying back to your TSP. Then what happens when you take money out of your traditional TSP during retirement? Yes, every dollar that comes out of your traditional TSP is taxed again!
Looking at the example above, if an employee takes a $20,000 loan and pays $5,000 of interest, it will take significantly more to pay the loan back. For an employee in the 22% federal tax bracket (still the bracket for many federal employees in 2026), it will take over $6,400 of earnings to pay the $5,000 of interest off, before any state income tax.
3. Your TSP is a retirement account, not a bank account or an emergency fund.
The TSP is designed to be a retirement account and it should be treated appropriately. Treating your TSP like a savings account is one of the most common ways that individuals hurt their retirement. That means that your TSP is designed to provide a retirement income. Too often I see employees take loans to start a small business, help family members, buy a car, build a house and so on. Other non-retirement accounts should be used for these types of needs. Having a savings account or emergency fund and implementing some delayed gratification can provide the resources needed for the items above.
4. It is not cheap money.
This point is related to the first but slightly different. One misunderstood benefit is that employees believe they can borrow money at a super low rate. This is in part true. The rate you pay is the G Fund rate when you take the loan, which was around 2% when I first wrote this and has been higher in recent years. But you are paying yourself back at that G Fund rate. Therefore, in this instance, you are not earning money on the loan (Point 1) and you are paying a low rate back to your retirement savings plan. A G Fund return does not sound like a very good investment return when the stock market has averaged close to 10% over the long run.
What happens to a TSP loan if you leave federal service?
This is one more risk to keep in mind. You can only take a TSP loan while you are a federal employee in pay status. If you separate or retire with a loan outstanding and don’t repay it by the deadline in the TSP’s notice, the unpaid balance is treated as a taxable distribution. If you are under 59½ and didn’t separate in or after the year you turned 55, you may also owe the 10% early withdrawal penalty.
What alternatives do I have to taking a TSP loan?
If your retirement is a priority, it would be best to avoid TSP loans. There are extreme circumstances when a TSP loan makes sense; however, they are usually few and far between. I cover one of them, high interest debt, in Credit Card Debt and a Good TSP Loan. The next time you consider taking a loan from your TSP, please consider alternatives such as the following:
- a loan from a bank
- refinancing your mortgage
- obtaining a home equity loan
- investigating other resources
- not taking a loan at all
Mortgage and home equity rates change with the market, so compare the actual rate you are offered with the cost of pulling money out of your TSP. And a loan is still usually better than an outright withdrawal; see TSP withdrawal to pay off debt for why.
The best way to avoid the need to take a TSP loan is to build your emergency fund as soon as possible. It is a good idea to have at least 3–6 months of living expenses saved in an emergency fund to help avoid the need of taking a TSP loan. That is one of the steps I recommend you do before maxing your TSP.
Educating clients on how to avoid TSP loans is one part of the service that we provide at Bobb Financial. You can find more articles and information for federal employees here.
Brad Bobb, CFP®, Bobb Financial, is an expert in federal benefits and retirement planning for federal employees.
This article is for educational purposes only and is not individualized financial advice. Figures are illustrative.