Beginning July 1, employees who wish to use their Thrift Savings Plan accounts as a source of loans will face new fees and restrictions.
Currently, there are two types of loans available to TSP participants — general-purpose and residential loans. General-purpose loans may be taken for any reason and must be repaid within five years. Residential loans may be taken only to purchase a primary residence and must be repaid within 15 years.
The minimum loan amount is $1,000. The maximum is $50,000, except under no circumstances may you borrow more than the balance of your own contributions plus their earnings.
You are required to repay the loan through payroll deduction according to a schedule you agree to when you take the loan, up to the maximum time allowed. The interest you pay is fixed at the rate of return on the G Fund at the time TSP receives your loan request. As of June 7, that rate was 4.625 percent. You may prepay the loan balance at any time without penalty.
Effective July 1, participants will pay a processing fee of $50 for each loan they initiate. Each participant will be limited to one general-purpose and one residential loan outstanding at any given time. Participants no longer will be able to have two general-purpose loans at one time. And, after repaying a loan, the participant must wait 60 days before initiating another loan.
These new provisions are designed to shift the cost of administering loans to those who use them and to reduce the volume of loan activity in TSP accounts.
Advantages
In spite of the new restrictions, there may be advantages to borrowing from your TSP account over other sources:
- Taking a TSP loan is convenient and requires relatively little paperwork.
- The cost to process the loan is low for larger loan amounts.
- You don’t have to qualify — you need only to have eligible assets sufficient to fund the loan.
- You pay a relatively low interest rate, and you pay that interest to yourself.
- As long as you keep your job, you will automatically repay the loan over a fixed period through payroll deduction.
- You may pay off your loan early without penalty, at your option.
Disadvantages
But, there are also important reasons to avoid borrowing from your TSP account:
- You must repay the loan in full within 90 days of separation from service, or the balance due will be declared a distribution subject to tax.
- When you borrow from your TSP account, your account balance is reduced by the amount of the loan plus processing fee. This money is taken from each fund held in your account in proportion to the funds’ relative weight in the account. While the money is out on loan to you, it is earning the rate of return generated by the G Fund at the time you took the loan. So, you may be exchanging higher returns on your money for lower returns. The longer the term of the loan, the more pronounced will be the effect on the value of your account.
- Making payments against your loan may divert resources that you would have contributed to your account had you not taken the loan. This can be a significant setback to your account on its own, but the damage is compounded if you also miss out on the opportunity to earn matching contributions.
- The interest you pay on a TSP loan is not tax deductible, even if used to buy a home, so the after-tax cost of a TSP loan might actually be higher than the cost of mortgage or home equity debt.
- The new processing fee may be a relatively large expense for smaller loans.
- The TSP repayment requirements are less flexible than the various options available on the private market. For example, TSP does not offer repayment terms longer than 15 years, variable interest rates or balloon loans.
Before you decide to borrow money from your TSP account, you should carefully consider the risks. You may wish to consider one or more of the following alternatives:
- Could you borrow the money from family members or friends under attractive terms?
- Do you have access to low-cost consumer credit, such as bank lines or promotional credit card offers?
- Could you take a home equity loan, establish a home equity line of credit or refinance your mortgage and take cash out?
- Do you have sufficient assets in taxable personal savings, or could you delay the need for funds until you save the money — without reducing your TSP contributions?
Written by Mike Miles
For the Federal Times
Publication June 14, 2004