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Tapping into your 401(k) early has historically been an absolute no-go.
The 2020 pandemic recession changed the rules for people facing tough times with no other options. But what about certain workers who don’t have a 401(k) to begin with, such as federal employees?
That’s where the Thrift Savings Plan, or TSP, comes in. Similar to a 401(k), the TSP can offer a last-resort source of funds to weather unforeseen financial challenges.
If you’re a federal worker and need to borrow money against your retirement funds, here’s what you need to know to make sure it’s the right decision first:
What Is a TSP Loan?
A TSP loan is a loan from a Thrift Savings Plan account. It’s similar to 401(k) loans in that you can borrow money from your retirement account, but it’s specifically designated for federal employees.
There are a few distinctions between loans from 401(k) plans and those from a TSP.
“There are some additional caveats to the rules around how much you can borrow from a TSP than there are for a 401(k) loan,” says financial planner Natalie Taylor. “The interest rate on a TSP loan is often lower than the interest rate on a 401(k) loan. And TSP loans are only available to government employees who participate in the TSP program.”
Like a 401(k) loan, interest repaid on a TSP loan goes back into your account, says Leslie H. Tayne, founder of Tayne Law in New York, a law firm focusing on debt relief. Compared to personal loans or other third-party credit available to you, this is attractive because you’re effectively paying yourself back, “rather than pursuing other traditional loan types where you would have to pay the interest back to another individual or institution.”
How Does a TSP Loan Work?
TSP loans come in two types: general purpose and residential. If you need to, you can take out one of each at the same time, as long as you meet the eligibility requirements.
Regardless of the type, TSP loans have some specific restrictions and limitations:
- You must be an active federal employee or a member of the uniformed services;
- You must have at least $1,000 in your TSP account — both contributions and earnings;
- Be in “pay status” or be entitled to receive pay, since loan repayments are in the form of payroll deductions;
- Not have had a taxable distribution within the last year;
- Not have a court order against your account;
- Not have repaid the same type of loan within the last 60 days;
Loan amounts range from $1,000 to $50,000
General purpose loans can be used for anything, similar to a personal loan. There’s no documentation needed for this type of loan, and depending on how much you borrow, your repayment terms can be anywhere from one to five years.
Residential loans can be used to buy or construct a primary home. This type of loan requires documentation, and you have up to 15 years to pay it back. Note that residential loans can’t be used to refinance or prepay a mortgage, or make additions or renovations to a home. Documents to be attached to the loan application include proof that you or your spouse are buying the property, proof of the purchase price, and proof of the property’s location.
For both, you’re limited in how much you can borrow. “The rules get a little tricky, but the maximum amount you can generally borrow is the smallest of either 50% of your vested account balance, or $50,000,” Taylor says. “The amount is limited to the amount of your contributions and earnings on your contributions.”
This limits the use of residential loans to essentially helping with a down payment or closing costs, with the median home price in the U.S. being more than $300,000 — well above the maximum you can borrow from a TSP.
TSP loans have fixed and currently very low interest rates: 0.875% at the time of publication. The rate in effect at the time the loan was made remains in effect for the life of it. To understand how monthly payments will work based on your loan, you can use the TSP.gov loan payment calculator.
Applying for a loan is straightforward, with an online application on the TSP site, which carries a $50 administrative fee. (You can apply via mail, but that means it will take longer to receive funds.) Spouses have rights pertaining to a TSP account, so applicants who are married need their consent too.
A TSP loan will likely be too small to buy a house, but it can be a good way to put together a down payment.
The loan will be issued in the form of a check, in eight to 13 days if the application was made online.
If you meet certain conditions, such as if you are a civilian and decide to perform military service, your loan can enter a condition known as “nonpay status” during which payments can be suspended for up to one year, or the duration of military service.
When Does a TSP Loan Make Sense?
Tapping into retirement savings should always be a last resort when faced with financial challenges. But if you do need to borrow money, there are generally a few different options, including personal loans, credit cards, and in some cases, a home equity loan or line of credit.
But credit cards have high interest rates; you might not qualify for a personal loan with a lower interest rate; and if you don’t own your home, you can’t get a home equity loan or line of credit.
“A TSP loan is a low-interest way to borrow money, so it can be a good option when compared to other high-interest debt like credit cards or personal loans,” Taylor says. “A TSP loan also doesn’t require underwriting, which means a low credit score won’t impact your ability to borrow TSP funds at a low-interest rate.”
Underwriting refers to the process of verifying income, assets and other details that lenders generally conduct before issuing a loan.
For those who meet the criteria, TSP loans can make sense if you truly need access to money to cover essential everyday expenses after a loss of income or an emergency.
TSP Loan Downsides
As the COVID-19 pandemic rolls on, you might need to make ends meet by borrowing from your future self. Again, in normal circumstances we would strongly advise against taking money out of your retirement fund to cover current costs, but these times aren’t normal.
As you think about a TSP loan, remember that your future self is losing potential earnings as repayments are taken out of your paychecks.
“The money you borrow misses out on the potential for growth in the stock market until it’s repaid,” Taylor says. “Payroll deductions that previously went to building your account value instead go toward loan repayment until your TSP loan is paid off, which also slows progress towards retirement.”
Also keep in mind the limitations on how much you can borrow. The maximum amount is $50,000, so if you need more than that, you may need to consider alternatives, like a personal loan or home equity loan, if possible.
If you’ve lost your job, face reduced hours or pay or you haven’t built an emergency fund yet, you might need to borrow money. If you have a TSP account and qualify to borrow from it, the low interest rates and easy repayment are a good option compared to alternatives.
But if you have other opportunities to tackle debt or late bills — like payment plans, negotiating with lenders, or borrowing money from relatives — those might help you get by as opposed to taking money from your future self.