TSP Loan? Step Away from the Paperwork...Please
TSP Taxes Military Pay and BenefitsI think one of the great benefits military officers have is access to the Thrift Savings Plan (TSP). But one of the options you have with the TSP can hurt your financial situation more than you might think. That option is the ability to take a loan from your TSP.
It can seem to make a lot of sense. You're paying 12 - 20% interest on a credit card. You can get loan from TSP for say around 7%. Take the loan and pay off the credit cards and save 5 - 13% in interest payments. It can be a good idea. But, before you go down that road, make sure you understand all the nuances.
Don't Neglect Opportunity Costs
Opportunity costs are what you give up (opportunities) when you go down one path. The opportunity cost associated with a TSP loan is the returns that you could earn on your investments if you leave the funds invested in TSP. Those returns should not be neglected. For the 10 years ending in 2018, the TSP funds generated the following returns:
- S Fund: 13.67%
- C Fund: 13.17%
- I Fund: 6.48%
- F Fund: 3.73%
- G Fund: 2.30%
So, if you're paying 12% on a credit card, you might want to look more closely at opportunity costs (granted, paying off the credit card is "risk free" and TSP returns are exposed to market risk).
Tax Ramifications
When you make contributions to the pre-tax side of TSP, your contributions are not subject to current taxation. That will change if you take out a loan. Let's say you earned and contributed $10,000 to TSP. You decide you need that $10,000 to pay off the credit cards. You pay off the credit cards and start paying off the loan. But you need to earn more than $10,000 to pay it off. Ignoring interest charges you'll need to earn somewhere around $13,500, depending on your tax bracket, to pay off the $10,000. Then when you take the money out, you'll pay taxes on the distribution of around $3,000 (again depending on tax brackets). So almost half of your earnings go to taxes.
If you've made contributions to Roth TSP, the tax ramifications aren't insignificant either. Let's take the same scenario. In this case, you earn $13,000 and contribute $10,000 to Roth TSP. After paying off your credit cards you'll need to earn $13,000 to pay off the $10,000 loan. At least you won't be taxed when you take the money out of Roth TSP. But, in essence you'll need to earn $16,000 to have $10,000 in Roth TSP (however, in this case you would have needed to earn $13,000 to pay of the $10,000 of credit card debt regardless).
Loan Acceleration
If you retire or separate from the military the loan accelerates and must be paid off within 90 days of your separation or the loan is considered a taxable distribution. And since you probably won't be 59 1/2 when you retire or separate from the military the distribution will be subject to a 10% penalty as well.
Military Benefits aren't Always Simple
Understanding your military and veterans' benefits takes time and effort. We do it every day. If you'd like some help with yours, give us a call.
If you found this article useful, you might like the following blog posts:
The Times (And TSP) They are a Changin'
What Military Officers Need to know about tSP and Estate Planning
Roth TSP in a Combat zone: Almost a "no Brainer"