Pay towards TSP loan or towards Mortgage?

[Scorpio70]

Definitely pay you TSP loan off first, after all you are the bank on that loan.

[stilljammi]

Serious question: why is maximizing TSP contributions a higher priority than paying off the TSP loan?

Because once the year ends, you won't be able to make those missed contributions any more. It's an opportunity lost forever.

It really only matters if you are able to put the maximum or more into your TSP each year.

Example: You can afford $25k/year for "investment cash available". 25k = Contribution + Loan Payment. Loan balance $40k 0% interest. For simplicity sake we'll say the Elective Deferral limit is 20k and doesn't change (it's currently 19.5k and tends to go up by $500 each year).

Case 1: Prioritize the loan. Put $5k/year into contribution, and $20k/year into loan.
Year 1: Contribution: 5k, Loan: 20k. Total net into TSP: 25k
Year 2: Contribution: 5k, Loan: 20k. Total net into TSP: 25k
Year 3: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 4: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 5: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 6: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 7: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 8: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k

That extra 5k you have available in years 3-8 can't be put to work in your TSP. So then it overflows into the next line on that hierarchy, which is taxed differently and isn't as beneficial as TSP contributions.

Total TSP inflows over 8 years: $170k. The rest of your investment cash available had to be forced into other investments such as a taxable brokerage account.

Case 2: Prioritize the contribution. Put 20k/year into contribution, and $5k/year into loan.
Year 1: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 2: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 3: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 4: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 5: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 6: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 7: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 8: Contribution: 20k, Loan: 5k. Total net into TSP: 25k

Now after the same 8 years the loan is finally paid off. But you've managed to put $200k into your TSP instead of 170k.

If that 30k being forced into taxable brokerage instead of the TSP it sets you up for paying capital gains tax on your earnings. Long term capital gains tax costs 15% for most taxpayers. The TSP and 401k plans are exempt from capital gains tax.

If that 30k gets pushed into medium interest debt, basically you gave up more than you gained, because the S&P 500 averages 7-8%, and instead of earning that, you're paying off debt at the rate of 5-7%.

Thanks, that all makes sense.

[bloobs]

Serious question: why is maximizing TSP contributions a higher priority than paying off the TSP loan?

Because once the year ends, you won't be able to make those missed contributions any more. It's an opportunity lost forever.

It really only matters if you are able to put the maximum or more into your TSP each year.

Example: You can afford $25k/year for "investment cash available". 25k = Contribution + Loan Payment. Loan balance $40k 0% interest. For simplicity sake we'll say the Elective Deferral limit is 20k and doesn't change (it's currently 19.5k and tends to go up by $500 each year).

Case 1: Prioritize the loan. Put $5k/year into contribution, and $20k/year into loan.
Year 1: Contribution: 5k, Loan: 20k. Total net into TSP: 25k
Year 2: Contribution: 5k, Loan: 20k. Total net into TSP: 25k
Year 3: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 4: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 5: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 6: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 7: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k
Year 8: Loan is paid off. Contribution Limit: 20k. Total net into TSP: 20k

That extra 5k you have available in years 3-8 can't be put to work in your TSP. So then it overflows into the next line on that hierarchy, which is taxed differently and isn't as beneficial as TSP contributions.

Total TSP inflows over 8 years: $170k. The rest of your investment cash available had to be forced into other investments such as a taxable brokerage account.

Case 2: Prioritize the contribution. Put 20k/year into contribution, and $5k/year into loan.
Year 1: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 2: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 3: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 4: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 5: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 6: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 7: Contribution: 20k, Loan: 5k. Total net into TSP: 25k
Year 8: Contribution: 20k, Loan: 5k. Total net into TSP: 25k

Now after the same 8 years the loan is finally paid off. But you've managed to put $200k into your TSP instead of 170k.

If that 30k being forced into taxable brokerage instead of the TSP it sets you up for paying capital gains tax on your earnings. Long term capital gains tax costs 15% for most taxpayers. The TSP and 401k plans are exempt from capital gains tax.

If that 30k gets pushed into medium interest debt, basically you gave up more than you gained, because the S&P 500 averages 7-8%, and instead of earning that, you're paying off debt at the rate of 5-7%.

Thanks, that all makes sense.

MJ proves that meticulius fact and evidence driven analysis is king.