TSP loan

[sonofnthng]

I currently have 2,800 left on a loan I took out 3 years ago. I'm not in any way implying that I will ever take another loan from my TSP, but I have a question regarding this comment on a Q/A site.

In the 3rd answer, by Michael Mez, he states that you will pay a tax penalty on income as a result of taking the loan out. Am I missing something, or is he foolish? We contribute pre-tax dollars, just as we would pay back a loan with pre tax dollars..... So, loan or no, (besides ROTH obviously) you'll have to pay taxes on the money you withdraw, just the same, right?

I think the answer to her question is How much time do you have to recover the hit to your TSP. I understand this is a game of compounding, so the higher the balance, the more you can earn.


So, just so I don't do anything foolish, myself, please reenforce me with your wisdom/advice.
I have 50k in my TSP. 25 years till retirement. I have saved up ~4k for an eventual down payment on a house. Is it smart to wait till I have the 20% in the bank (which may take 5 more years) or if I found the perfect place, take out TSP $ (~10k) for the down.

My thinking is, if I can lower my cost of living (rent is 1100) by a few hundred, I can put that right back toward the loan, and also be investing in my own property. But also, that I'd be setting myself back, ruining my chances of seeing a big balance, provided I don't die.

[mjedlin66]

Actually, you pay back the TSP loan with post-tax dollars, which is exactly the way it is supposed to be.

Say you have a 10k pre-tax TSP and a 25% tax rate. You need a 10k downpayment for a house. Normally, the 10k for the house would be paid with post-tax money. But when you take the loan out, you receieve 10k of pre-tax money. So far, you have paid $0 in tax. To make up for this, you pay tax as you repay the 10k loan. After the loan is paid, you have paid $2500 in taxes, which is exactly what you owed for the tax on the 10k equity in the house. You once again have a 10k balance in your pre-tax TSP, and 10k of post-tax equity in your house. When you retire, you will pay $2500 in tax on withdrawing that same 10k from your TSP. Total life tax bill: $5000.

Now consider you have 10k Roth TSP, and you are in the same situation. You have already paid $2500 in taxes for the Roth balance. You withdraw 10k of post-tax money to use for a down payment which would normally be post-tax. Still, the loan payments are after tax. Once the loan is repaid, you have paid tax on the 10k in your house ($2500) AND the 10k in your TSP ($2500). When you retire and withdraw from the TSP in retirement, you do not pay tax. Total life tax bill: $5000.

In both situations, everything works out exactly the correct way.

[mjedlin66]

As to your second question, it does not sound like you are maxxing out your TSP contributions each year (18k/year). If that is the case, I highly recommend that you contribute 100% of your house down payment savings into the TSP. Don't use your bank account for that purpose. The reason is that if you need 10k for a down payment, and your TSP is growing, then you may only need to put away 8,000-9,000 or so over time. With compounding growth, your TSP will turn your 8 or 9k in contributions into the 10k that you need for your house. Your checking or savings accounts cannot do that. Plus, once you completely repay the loan, your TSP balance will be higher than if you hadn't done this (assuming that your contributions stay the same as they are now, and you do not decrease contributions in order to make the loan repayments).

[sonofnthng]

But, that 2500 you pay in tax as you pay the loan back goes into your balance. It's your money.. So, if you take 10k, pay 2500 on it, you now have 12500. So upon withdraw, you would pay 3000 in tax on it, no?

Also, my savings account pays 1.125 percent interest, which is pretty good for savings. The reason I keep a savings account is because it's important to have emergency cash. Aren't you supposed to have 3-6 months worth of expenses in a savings account?

So you're saying that if I took 10k out and my balance went back down to 40k, my balance would be bigger than if I didn't take the loan out? I'm not sure I follow.

Thanks for the detailed responses though!

[evilanne]

But, that 2500 you pay in tax as you pay the loan back goes into your balance. It's your money.. So, if you take 10k, pay 2500 on it, you now have 12500. So upon withdraw, you would pay 3000 in tax on it, no?

I think you are missing mjedlin66's point. The $2,500 doesn't go to TSP account it goes to the federal government assuming your marginal tax rate in 25%. You pay off the loan with after tax dollars. Most people probably don't pay attention to this if you have the appropriate withholdings set up for your pay check. If it is paid off in 5 years, that is only $500/year. If I convert $10K from a regular IRA to a Roth IRA, I will have to pay an additional $2,500 in taxes this year. The $3,000 would only apply if you change the assumption to 30% marginal tax rate.

The interest, which goes back into your account, is a different issue from taxes.

[Jock14]

The reason I keep a savings account is because it's important to have emergency cash. Aren't you supposed to have 3-6 months worth of expenses in a savings account?

Passing on a little advice my financial advisor gave me:

It's good to have 3-6 months of expenses as "accessible" cash. This doesn't necessarily mean it has to be in a savings account. Some retirement accounts, stocks portfolios, etc can be accessed in case of emergency. If you have enough of your portfolio accessible, that can act as your "emergency cash". In other words, it can be making (or losing) money with the rest of your account.

Not that the TSP loan is a GOOD example, but it is AN example of funds that are accessible in case of emergency. The funds can be invested and growing (hopefully better than a savings account) while no emergency is occurring, but can be accessed quickly with (ideally) a low penalty IF something ever occurred.

An example of something that wouldn't count toward accessible cash would be a ROTH IRA account that you can't touch (without serious penalty) until 59 1/2.

[skiehawk11]

Jock14, that's brilliant. I've never thought of a TSP loan as an emergency fund of sorts. The only downside to that is that you have to wait 6 months after the last loan is paid off to get a new loan (I think). Am I wrong?

[squatchETF]

Jock14, that's brilliant. I've never thought of a TSP loan as an emergency fund of sorts. The only downside to that is that you have to wait 6 months after the last loan is paid off to get a new loan (I think). Am I wrong?

"Must not have repaid a TSP loan of the same type in full within the past 60 days. (If you have both a civilian TSP account and a uniformed services TSP account, the 60-day waiting period applies separately to each account.)"

[sonofnthng]

ok evilanne, I'm understanding a bit more now... thanks for the clarification.

Jock, that's a good call. I feel like 3k is a good balance to always have in readily accessible cash if I add more tattoos to the collection or take a road trip to Yellowstone or spend more weekends in Philly, etc. If I need 200 bucks, I just transfer it on the app and it's there.
But the 3-6 month would be more like 6-12k, which could be growing in the TSP, for sure.

[mjedlin66]

A new tattoo should be paid for with a new budget allocation. Actively tracking my budget every month is awesome. It has all but eliminated purchases on a whim. If I truly want something, I have to sit down with my wife and figure out how we are going to pay for it. For instance, I want $800 for ground school. So we looked at our monthly budget and took $50/month from the beer budget and $50/month from the eating out budget. I will take ground school in 8 months. I can study my Japanese in the mean time.

I could afford to just blow the money now. But the point of the budget is to plan for everything. Because we have an active budget, our monthly expenses are much lower and we can save more. I project that we will invest 60k/year from now on, all of which is post-tax.

[sonofnthng]

My monthly bills leave me about 500, and I put 200 of it into the saving acct. I've been collecting tattoos for 10 years, and usually do 2 or 3 sessions a year at ~500. That's not even something I have to think about. \\ You are on point, sounds like you use the envelope system. I try to do the same. I don't spend $ willy nilly without thinking about it, and I'm all about structure and routine.

[mjedlin66]

Actually we use "you need a budget", which we both have on our cell phones so we can add transactions quickly and easily following payment. I impulse bought a clutch pedal for my 67 mustang this month and it hit our "Miscellaneous" budget, so our miscellaneous budget is already 0 for the month. In hindsight, I just bought a car part for my project car which is halfway around the world from me. I won't be installing the thing for 5 years maybe. Watching the purchase empty my misc. budget for the month was sobering.

[tomleeinar]

Taking $50 from the beer budget? That's just crazy talk!!

[mjedlin66]

Taking $50 from the beer budget? That's just crazy talk!!

That's easy. We make beer, so all we have to do is make more and buy less.

[sonofnthng]

Upon further investigation, I think you guys are misinformed about that tax situation. The only thing you pay double tax on is the interest, not the amount of the loan. Do yourselves a flavor and read this

http://www.tspallocation.com/tsp-loan-g ... tsp-loans/