How to Repay a TSP Loan After Retirement

The Federal Thrift Savings Plan is roughly equivalent to a 401(k) plan that a private employer might offer. Made available to federal employees, the TSP offers a limited selection of extremely low-cost funds in which you can invest. It offers the same tax-deferral as a 401(k) while also having a loan feature that lets you tap into your money on a tax-free basis if you need access to it before you retire.

TSP Loan Provisions

When you have a TSP account, you can borrow some of the money you put into it. The TSP's rules cap loans at half of your balance or $50,000, whichever is less. You have to pay back the loan within five years, unless you're taking money out to buy a house, in which case you get up to 15 years to pay it back. When you take out a loan, you also have to pay interest, but you pay it to yourself. Not paying back the loan on time, though, can have tax consequences.

Loans and Retirement

When you retire from federal service or you separate from government for any other reason, loans from your TSP program come due. The loan has to be paid back within 90 days of your separation. If you don't pay it back, the TSP will treat the money that isn't repaid as a distribution and you will have to pay taxes on it.

The Cost of Distributions

When you don't repay your loan and it gets counted as a distribution, it could be subject to two different types of federal tax. First, it's taxed as income at your regular income tax rate. This means that if you have a $25,000 loan outstanding and you don't pay it back, you would have to pay $7,000 in tax, assuming you pay taxes in the 28 percent bracket. Second, if you retire before the TSP's official retirement age of 55, you'll also have to pay a 10 percent penalty for the early withdrawal. On a $25,000 withdrawal, that adds an additional $2,500 in taxes.

The Problem With Loans

When you take a normal distribution, you get the money, and a portion goes to taxes. If you take $25,000 and pay 28 percent tax, you essentially end up getting $18,000. When you have a loan, though, and don't repay it, you could end up having to pay the $7,000 or more in tax without having any extra money coming in to pay for it, because you already spent it when you originally took out the loan. The other problem with a TSP loan is that, while you're paying interest to yourself, if the rate you pay is less than what your TSP investments would have earned otherwise, you miss out on all of that growth.

About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.

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