As we know, the TSP is a top tier retirement account. When it comes to putting away money for retirement, it is second to none. For that reason, feds should be stashing as much excess money into the TSP as manageable. Doing so is a key part of any long term strategy for Feds building the funds needed later in life. However, due to the restrictions on taking a withdrawal from the TSP while still in government service, it can be problematic if a short term need for extra cash happens to arise. There are only three ways to withdraw money from your TSP while still working your federal job: an in-service withdrawal, a hardship withdrawal or a TSP loan. In general, taking an in-service withdrawal from the TSP should be avoided, and hardship withdrawals can only be made under specific circumstances. That leaves TSP loans as the most reasonable method of removing funds from your TSP. Keep in mind this is the lesser of three evils, if you will. Funds should only be removed from the TSP before retirement if absolutely necessary. TSP loans come with more favorable terms than an in-service withdrawal and may actually be useful in certain situations. Of course, it’s vital to consider your situation to determine whether or not removing money from the TSP is warranted by a true need.

Should You Take Out a TSP Loan?

Before worrying about anything else, the most important question involving a TSP loan needs be addressed: do you really need one? The decision to take a loan from the TSP should be based on two key factors: the use of the money and the ability to pay it back. The TSP should not be viewed as a credit line for personal consumption purposes. Although I do maintain the opinion that your money (in a 401K or not) should always be used to maximize your personal utility throughout the entirety of life, it’s equally as important to keep your financial perspective in check. The problem is that actual desires become blurred with fictitious wants when larger sums of money suddenly become available. If you start to view your TSP as funds that can be used for current wants, rather than for future needs, financial trouble will be inevitable. The criteria for what constitutes a useful withdrawal is of course highly personal, but it should generally be for productive, not consumptive, purposes. Additionally, you must be sure of your ability to make the repayments on the loan. If for any reason you cannot repay the loan, the loan will then be treated as a distribution from your TSP, triggering taxes and potential penalties.

How TSP Loans Work

Taking a loan from the TSP is not much different than taking a loan from a bank. Except with the TSP, you are also the bank. Fortunately, since you are borrowing the money from yourself, the interest on the loan is also being paid back into your account. This is what makes it so advantageous in comparison to other methods of financing—repaying yourself is clearly a more favorable move than paying a bank. It’s important to remember that although you’re being paid interest, rather than paying interest with a TSP loan, you may miss out on the investment gains that would have accrued in your account if the money had stayed invested. In a bull market like the one we’ve experienced over the last 8 years, taking money out of your TSP could have proven very costly.

The Two Types of TSP Loans

There are two types of TSP loans: General Purpose and Residential.

• General Purpose: As the name implies, this loan is for any general purpose. This is basically a no questions asked loan from your TSP. It doesn’t matter if it’s for a weekend in Vegas or a lifesaving surgery, you can borrow from the TSP for any reason with this loan.
• Residential: A residential loan is required to be used towards the acquisition or construction of your primary residence. The term “residence” is defined fairly loosely by the TSP as: “a house, condominium, shares in a cooperative housing corporation, a townhouse, boat, mobile home, or recreational vehicle.” Residential loans cannot be used to refinance or pay down an existing mortgage, renovations or repairs, or for buying land.

The Rules for Borrowing

When it comes to any financing arrangement, rules and restrictions always apply. Here are the key rules that govern loans from the TSP:

• Currently Employed: First and foremost, you must be actively employed by the government as a Federal civilian or military member. Since the payments on the loan are deducted from your future paychecks, you must be in a pay status.
• Minimum Loan Amount: $1,000 is the lowest amount that may be borrowed from your TSP. Therefore, you must have at least $1,000 of your own contributions and earnings in the account. This means that the match provided by the government cannot be included to arrive at this minimum.
• Maximum Loan Amount: Typically, the most you’ll be able to borrow from the TSP is $50,000. However, your personal maximum may be smaller than this due to the restrictions the TSP puts on the calculation of an individual’s maximum. The restrictions require that the smallest of three calculations is what will be used: the total of your own contributions and earnings, 50% of your total vested account balance or $10,000 (whichever is greater), or $50,000 minus your highest outstanding loan balance (including those paid off in the last 12 months). If you have any outstanding loans, these play a factor in those calculations in various ways. In that case, it’s best to consult the specifics on the TSP’s website.
• Repaid Loans: You must not have repaid a TSP loan of the same type (general or residential) within the previous 60 days.
• Taxable Distributions: You must not have withdrawn money in a taxable manner (not in a loan or eligible age requirement) within the last 12 months.

Borrowing funds from a retirement account such as the TSP is typically frowned upon, but that’s not to say it can never be a useful move. Although, among the other risks, there is a limit on the amount of funds that can be placed into tax-advantaged accounts each year to help fund your retirement. It’s important to make an informed, rational decision, and to consult a professional if needed before taking funds out of your TSP.