Tapping your 401 (k) early on has historically been an absolute no-go.
The 2020 pandemic recession has changed the rules for people who face difficult times with no other options. But what about certain workers who do not initially have a 401 (k), such as B. Federal Employees?
This is where the Thrift Savings Plan or TSP comes into play. Much like a 401 (k), the TSP can provide a last resort resource to help meet unforeseen financial challenges.
If you’re a federal employee and need to borrow money for your retirement savings, here are some things 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 savings plan account. It is similar to 401 (k) loans in that you can borrow money from your retirement account, but it is specifically designed for federal employees.
There are some differences between 401 (k) plan loans and those from a TSP.
“There are some additional caveats to the rules about how much you can borrow from a TSP than there is with 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. “
As with a 401 (k) loan, the interest paid back on a TSP loan comes back to your account, says Leslie H. Tayne, founder of Tayne Law in New York, a law firm focused on debt relief. Compared to personal loans or other third party loans that are available to you, this is attractive because you are effectively paying yourself back “instead of pursuing other traditional types of loans where you would have to repay the interest to another person or institution”.
How does a TSP loan work?
TSP loans come of two types: general purpose and home loans. If necessary, you can complete one of these at a time, provided you meet the admission requirements.
Regardless of the type, TSP loans have some specific limitations and restrictions:
- 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 “wage status” or have the right to wages, as loan repayments are made in the form of wage deductions;
- have not had a taxable distribution in the previous year;
- there is no court order against your account;
- have not paid back the same type of loan in the last 60 days;
The loan amounts range from $ 1,000 to $ 50,000
General purpose loans can be used for anything, much like a personal loan. No documentation is required for this type of loan and depending on how much you are borrowing, your repayment terms can be anywhere from one to five years.
Home loans can be used to buy or build a home. This type of loan requires documentation and you have up to 15 years to repay it. Note that home loans cannot be used to refinance or prepay a mortgage, or to expand or renovate a home. Documents to accompany 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.
With both you are limited in the amount you can borrow. “The rules get a bit tricky, but the maximum amount you can generally borrow is the smallest of either 50% of your balance or $ 50,000,” says Taylor. “The amount is limited to the amount of your contributions and income from your contributions.”
This limits home loan use to essentially helping with a down payment or closing costs, with the average home price in the US 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 interest rate valid at the time the loan is granted remains valid for the entire term. To understand how the monthly payments work based on your loan, you can use the TSP.gov loan payment calculator.
Applying for a loan is easy with an online application on the TSP site which has an administration fee of $ 50. (You can apply by mail, but that means it will take longer to receive the money.) Spouses have rights in relation to a TSP account, so married applicants will also need their consent.
A TSP loan is likely too small to buy a home, but it can be a great way to pay a down payment.
The loan will be issued in the form of a check in eight to 13 days if the application is submitted online.
If you meet certain conditions, e.g. For example, if you are a civilian and choose to do military service, your loan may take on a so-called “non-payment status,” which means that payments can be suspended for up to a year or the duration of your military service.
When does a TSP loan make sense?
Developing old-age provision should always be the last resort when faced with financial challenges. However, when you need to borrow money, there are generally a few different options available, including personal loans, credit cards, and in some cases a home loan or line of credit.
But credit cards have high interest rates; You may not qualify for a personal loan with a lower interest rate; and if you don’t own a home, you can’t get a home loan or line of credit.
“A TSP loan is a low-interest way to borrow money, so it can be a good option compared to other high-yield debt such as credit cards or personal loans,” says Taylor. “A TSP loan also does not require underwriting, which means that a low credit rating will not affect your ability to borrow TSP funds at a low interest rate.”
Underwriting refers to the process of reviewing income, assets, and other details that lenders generally perform before making a loan.
For those who meet the criteria, TSP loans can make sense when you really need access to money to cover essential daily expenses after a loss of income or an emergency.
Disadvantages of the TSP loan
As the COVID-19 pandemic continues, you may have to make ends meet on credit from your future you. Again, under normal circumstances, we strongly advise against taking money from your pension fund to cover the running costs, but these times are not normal.
When considering a TSP loan, keep in mind that your future you will lose potential income as the repayments will be deducted from your paychecks.
“The money you borrow is missing the growth potential of the stock market until it is paid back,” says Taylor. “Deductions from wages previously used to build your account value will instead go into loan repayment until your TSP loan is paid off, which also slows progress toward retirement.”
Also, be aware of the restrictions on how much you can borrow. The maximum amount is $ 50,000. So if you need more, you need to consider alternatives like a personal loan or a home loan whenever possible.
If you’ve lost your job, faced reduced hours or pay, or haven’t yet built up an emergency fund, you may need to borrow. If you have and qualify for a TSP account, the low interest rates and easy repayment are great options compared to alternatives.
But if you have other ways to address debts or late bills – like payment plans, negotiating with lenders, or borrowing money from relatives – these can help you instead of taking money from the future you.