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Four Reasons Not to Take a TSP Loan

Federal Employees

Taking out a loan against your TSP has become a pretty common practice with federal employees. Even federal employees with high incomes have taken money out of their TSP because it is a “good deal.” As many of us have seen in life, just because it sounds like it’s a good deal, doesn’t mean it actually is. Despite sounding like a good deal, I would like to offer four reasons as to why it isn’t a good deal, and why you shouldn’t take that TSP loan.

1. You aren’t earning anything on your loan balance.

If we look at historical averages, the market makes money more often than not. With that being said, when you take a loan out of TSP, you are not making 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 make money (due to compounding)  for as long as you keep money in TSP.

2. You are taxed twice on the amount of the loan.

Who enjoys paying more taxes than you 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 loan back, you are making payments with after tax dollars, which means you paid taxes on every dollar that you are paying back to your TSP. Then what happens when you take money out of your TSP? Yes, every dollar that comes out of your TSP is taxed again! 

 

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 not be treated as if it were a bank account that you can tap into whenever you want. This is one of the most common ways that individuals hurt their retirement.  A great way to avoid the need to take a loan from your TSP is to have an adequate emergency fund. Savings in TSP are designed to provide a retirement income, and should be treated as such.

4. It is not cheap money.

This point is related to the first but is a little different. One misunderstood benefit is that employees believe they can borrow money at a super low rate, like 2%. This is kind of true, but you are paying yourself back at around a 2% rate. So, not only are you not making money on the loan (point 1), you are paying a super low rate back to your retirement savings plan. Two percent doesn’t sound like a very good return when the market averages close to 10%.

What should I do?

If you are concerned about your retirement, 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. Next time you consider taking a loan from your TSP, please consider alternatives such as a loan from a bank, a mortgage or home equity loan, or even not taking a loan at all. The best way to avoid the need to take a TSP loan is to build your emergency fund as soon as possible.

If you would like more information on how I counsel federal employees on everything from TSP loans to retirement planning, please contact me at (217)697-5589 or brad@bobbfinancial.com.


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