The High Cost Of Cashing Out
The repercussions of cashing out of your TSP could be enormous. For example, lets assume you are 30 years old and have a TSP balance of $20,000. If you leave that money in your TSP account or put it in an IRA, and your account averages a six percent rate of return over the next 32 years, your balance at retirement will total $129,068, even if you do not make any additional contributions during that time.
Even if you have a shorter time horizon, you will forgo significant savings opportunities by cashing out your TSP. For example, if you are 45, your $20,000 would grow to $53,855 in 17 years.
Keep in mind that even if you really need the money, you may be better off borrowing from your TSP account. You may be able to borrow at a lower rate from your account than you could from a bank or other lender, especially if you have a low credit score. You must be in pay status to obtain a loan, because your regular monthly loan payments are made through payroll deductions.
To learn more about TSP loans, click the TSP Features/Uniformed Services button at the TSP website, then go to the TSP Loan Program link.
When you leave military service, carefully examine the short- and long-term consequences before cashing out of your TSP account. After all, when talking about tax-deferred savings plans, time is money.
Why Tsp Loans Should Be Avoided
There are four reasons that TSP loans should be avoided. These reasons are explained below. Since most TSP participants have contributed over the years, mostly if not entirely to their traditional TSP accounts, the assumption is made that TSP loans are coming from the traditional TSP account.
- Reason #1. Contributions that have been made to the traditional TSP are deducted from an employees gross salary. That is, from salary that has not been taxed. Once that same salary is taken out in the form of a TSP loan, the loan borrower will pay the money back with after-taxed dollars, namely the dollars that arrive in ones bank account via payroll.
- Reason #2. TSP loan proceeds are taxed twice. The first time is when the withdrawn loan proceeds are paid back with money coming from the TSP participants bank accounts, which have already been taxed. The second time is when the TSP participant retires and withdraws from his or her TSP account, the participant will pay full tax on the amount withdrawn. The amount withdrawn consists partly of the TSP loan proceeds which were paid back with after-taxed dollars.
- Reason #4. If the TSP participant leaves or retires from Federal service with a TSP loan, he or she has up to 60 days from the day of departure or retirement to repay the loan in its entirety. If repayment is not made in full, then the participant will face the same tax and penalty consequences as a participant that had defaulted on the loan.
Using Tsp To Pay Off Debt
I have a tsp question for you concerning the new TSP withdraw options. I retired in 2015 from air traffic control at age 50. Will I be able to make a withdrawal? I would like to withdraw maybe $20000 to help pay some debt. If I can do that what is the tax rate and what will it do to my taxes at the end of the year? Thank you for any help you can give. Im not sure who I can ask these questions. Ive read the fact sheet but it doesnt address this specifically. Susan
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Heading Into Retirement With A Tsp Loan
If you are nearing retirement age and are still paying off a TSP loan, you need to do some additional planning. If possible, its best to pay your loan off before retirement age. If youd like to retire before your loan is knocked out, you can make additional payments by sending a check in the mail along with a loan payment coupon. You can pay a little extra each month, use your tax refunds to give yourself a boost, or pay the balance in one lump sum if you can afford it. Were happy to help you calculate the best plan for your situation!
If you arent able to pay your loan down early, dont worry: you can still retire with an outstanding TSP loan. No one will force you to continue working until its paid off.
However, there are some drawbacks to be aware of if your loan is unpaid at the date of your retirement.
The TSP is required by law to report any unpaid loan balance for both General Purpose and Residential loans as a taxable distribution. You have a 90-day grace period to pay it off before this happens.
If you cant pay the remaining balance by then, you will owe income taxes both federal and state at your regular rate on the outstanding balance and interest. Depending on the size of your balance, this could be a sizable tax trap that eats up your refund and could even leave you owing a big chunk of change come April.
How To Get A Tsp Loan
You can apply for a TSP loan online by logging into My Account at www.tsp.gov. You might be able to complete the entire loan application process online. However, you might be asked to print the loan request. If prompted to print the application, ensure that all fields are correct, and include additional documentation thats asked of you. You can either upload the paperwork to your TSP account or send it by mail or fax.
Whether youre required to print out the form depends on a few factors. For example, your marital status, the TSP loan type requested, or how youve chosen to receive the loan funds.
If youre a Federal Employees Retirement System participant or a uniformed service member and are married, your spouse must sign the Loan Agreement to signify their consent. Similarly, your spouse will be notified if you are applying to a TSP loan as a Civil Service Retirement System participant. In rare circumstances, there have been exceptions to TSP loan rules regarding spousal consent.
The Thought Of Paying Off Your Car Loan Early And Doing Away With Your Monthly Payment Is Appealing But Should You Do It
Maybe you have a little extra cash each month, or you recently came into a large amount of money. Should you use those funds to pay off your car loan early? There are potential benefits, but also some possible drawbacks, to consider when deciding whether to pay off your auto loan ahead of schedule.
Tax Consequences Of Using The Tsp To Pay Down Debt
One of the most overlooked aspects of retirement planning is tax planning. When you are in the thralls of your career earning taxes are always part of the financial planning process. But when people go to retire, they assume because their income is going to be less in retirement their taxes will be too.
What most employees who retire under FERS forget is that most of your retirement savings have been tax-deferred.
Meaning, when you enter retirement and start withdrawing or receiving money from these tax-deferred accounts, you will have to pay taxes. You will have to pay the worst kind that there are: ordinary income taxes!
When you use the TSP to pay down debt, you need to consider what account you are going to pull money from and what tax status those accounts are in.
The only tax-free withdrawal options that you have from the TSP are:
All other withdrawals are subject to ordinary income tax. Sometimes the Feds that we work with assume that because the TSP is an investment account that their withdrawals will be taxed at capital gains rates, generally lower for most people than ordinary income tax rates, but they are not.
If you have never withdrawn money from the TSP before keep in mind that the TSP office is REQUIRED to have 20% tax estimate withheld to send to the IRS.
In Susans case, if she wanted to withdraw $20,000 then the TSP office is going to send $4,000 to the IRS.
Meaning, Susan is going to receive $16,000.
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Withdrawals Before Age 59
If you pull money out of your 401 plan before age 59½, thats generally considered an early or premature withdrawal and subject to both income tax and a 10% early withdrawal penalty.
Suppose you take $45,000 from your 401 to pay off debt. For starters, youll face a $4,500 early withdrawal penalty. On top of that, youll also owe income tax on the $45,000. For example, if youre single, and your other taxable income is $100,000, then your $45,000 withdrawal will be taxed at 24%, or $10,800 .
So, in total, your $45,000 withdrawal will cost you $15,300 and leave you with $29,700 to apply to your debts.
Why Would Someone Take A Tsp Loan
There are probably a lot of reasons someone would take a TSP loan. However, well focus on the two reasons that are probably most common:
Lets look at each of those a little more closely.
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What Are The Advantages Of Thrift Savings Plan Loans
The interest rate is very low and you are paying it to yourself instead of to a bank. So the loan is essentially free to you, other than a small administrative charge.
You avoid the 10 percent penalty on early withdrawals from retirement accounts. If you arent old enough, or are old enough but havent separated from federal service, you would have to pay this penalty if you withdrew the money outright.
The fee charged for TSP loans is a very low, flat fee of $50.
The TSP loan application is quick, easy and straightforward. No one is turned down for a loan assuming sufficient employee contributions and earnings. No credit check is required. Other types of loans require a more complex application process, a credit check and more fees.
There is no negative impact on your credit score. A TSP loan does not appear on your credit report, because it is not really a loan . If a TSP loan borrower loses his or her job, retires or leaves federal service and is unable to pay off the loan balance, the unpaid balance will be classified as a distribution for which income taxes must be paid, but it will not show up on your credit report as a default.
Making Room For Aunt Irs
As a Federal Employee, your TSP is tax-deferred.
That means, the monies accumulated in this investment have not yet been taxed.
When you made a contribution , to your traditional TSP, you did so on a pre-tax basis. This is often done so that you have less taxable income during your working years.
Here is a simplified example of what that could look like:
Example: $100,000 base salary. 18,000 Employee Contributions to a Traditional TSP= $82,000 Taxable income on your W-2
As those funds within the account grew, they did so on a tax-deferred basis.
Look around the dinner table tonight and see if you set a place for your beloved Aunt IRS .
You may not have thought about her yet, but we promise you, when you pull those funds out of the traditional TSP she is going to want a seat at the table.
The US uses what you can call a progressive tax system the more money that you earn, the more you pay in taxes.
When you make a distribution of your TSP, your taxable income was just increased by the amount that you withdrew from your traditional TSP.
Making a large distribution like this could quickly escalate the tax bracket that you are in.
All great information but how does it work? Well, lets walk through an example.
We began talking about paying off a mortgage of $300,000 which is what we will continue with here in this example so that we can see how one such example might work.
Lets say that you are a Married Filing Joint couple who has a gross income of $150,000.00.
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Loans To An Employee That Leaves The Company
Plan sponsors may require an employee to repay the full outstanding balance of a loan if he or she terminates employment or if the plan is terminated. If the employee is unable to repay the loan, then the employer will treat it as a distribution and report it to the IRS on Form 1099-R. The employee can avoid the immediate income tax consequences by rolling over all or part of the loans outstanding balance to an IRA or eligible retirement plan by the due date for filing the Federal income tax return for the year in which the loan is treated as a distribution. This rollover is reported on Form 5498.
You Have A Mortgage But You Also Have Enough Money To Pay It Off Should You
Many federal employees, as they approach retirement, have paid off all their debt except for their mortgage. They have saved diligently through the Thrift Savings Plan and they have a good-sized nest egg. It seems to be a match made in heaven. You have this debt and you have enough money to pay it off, so shouldnt you? Its a question I hear all the time from feds and I can see why.
The short answer: Probably not. But the long answer is worth considering.
First: Are you at least 59½? If you arent, any withdrawals may be subject to a 10% penalty as well as taxes. Sometimes this penalty is waived if you have already retired but I would do thorough research beforehand to make sure you are in the clear.
The Big One: Taxes
For most feds, most of their TSP savings is on the traditional side and not the Roth. This means that when you put the money in, you didnt have to pay taxes on that money, but you do when you take it out. If you do have money in the Roth TSP, any qualified distribution will come out completely tax free.
One misconception that I see is that some feds assume that traditional TSP distributions will be taxed at capital gains tax rates, but this is not the case. These distributions are simply added to your income in whatever year you take the money out.
Lets do a quick example to see how this would work.
Opportunity Cost: The Second Kicker
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How Long Does A Tsp Hardship Withdrawal Take To Process
It generally takes between 7 to 10 business days to process your request once youve properly completed and submitted it. We disburse withdrawals each business day. You can check My Account at tsp.gov or call the ThriftLine to find out the status of your withdrawal request, including whether the payment has been made.
What Is A Tsp Loan
When you have a TSP account, you are allowed to take out a loan against your own investment. This is similar to borrowing against a 401 plan in the private sector. There are two types of TSP loans: General Purpose and Residential. A General Purpose loan can be used for any reason and must be paid back within 5 years. A Residential loan must be used to buy or build a primary residence and must be paid back within 15 years.
TSP loans are attractive because they currently have a much lower interest rate than a commercial mortgage, student loan, or other financing and a very much lower interest rate than a credit card. Theyre also convenient because youll repay the loan with payroll deductions that come directly out of your paycheck, so you never have to worry about missing a payment.
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How To Pay Down 401 Loan Quickly
If you are planning to pay off the 401 loan early, the first thing you should do is to check your plan document and loan policy to see what is allowed. Some plans allow 401 prepayments if the participant plans to pay off the outstanding balance either as one lump-sum payment or as additional payments above the regular periodic payments.
Depending on what your 401 plan allows, you can increase the periodic payments or set aside the extra payments in a savings account until you have accumulated enough balance to pay off the loan in full. If your employer only allows loan payments via payroll deductions, you must adjust the withholding to increase the regular payments. On the other hand, if the employer accepts checks, you can make a lump-sum payment using a check to clear the outstanding balance.
Invest The Money Opportunity Cost
The opportunity cost of paying off your mortgage vs youroptions is just too high.
Paying off the mortgage saves you the interest rate. Thats nowhere near what you could make if you invested in the S& P 500 or a similar index fund long-term.
I invest in real estate. My investments do better than index funds do.
Id choose between the stock market or real estate before I paid off a mortgage again.
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Paying It Off Decreases Your Expenses
The argument here is, by paying off your mortgage you haveless expenses.
This may be true, but its extremely simplified thinking, and shows a lack of understanding of the power of compound interest and investing over the long-term.
If you would have taken the money that you used to payoff your mortgage, and put it either in index funds or in good real estate investments, you would more than likely have a substantial sum of money. Eliminating a mortgage would pale in comparison to what you could do with your newfound wealth.
It could allow you to travel, visit friends, donate to charities,etc.