TSP Loan Rules Since the Roth TSP Was Introduced

TSP Loan Rules

In general, a Thrift Savings Plan (TSP) participant can borrow from their TSP account if:

– The participant has at least $1,000 of his or her own contributions (traditional and Roth TSP contributions combined) and associated earnings in the account. The agency automatic one percent contribution and matching contributions (FERS employees only) cannot be borrowed;

– The participant is currently employed as a federal civilian employee or member of the uniformed services (separated or retired participants and beneficiary participants are not eligible to take out TSP loans);

– The participant is in pay status (loan repayments are deducted from an employee’s paycheck);

– The participant has not repaid a TSP loan of the same type in full within the past 60 days; and

– The participant has not had a taxable distribution on a loan within the past 12 months, unless the taxable distribution resulted from the participant’s separation from federal service.

Types of TSP Loans

There are two types of TSP loans, namely:

1. A general purpose loan with a repayment period of one to five years. There is no formal justification or documentation required for a general purpose loan; and
2. A residential loan with a repayment period of one to 15 years and required documentation as is discussed below.

A residential loan can be used only for the purchase or construction of a primary residence. The residence can be a house, condominium, shares in a cooperative housing corporation, a townhouse, boat, mobile home or a recreational vehicle. But it must be used as a primary residence of the TSP participant. A TSP residential loan may not be obtained to refinance or prepay an existing mortgage, renovations or repairs, for buying out a partner’s share in a current residence, or for the purchase of land only.

A participant may have only one general purpose loan and one residential loan outstanding at any one time. The minimum loan amount a participant can borrow is $1,000 of the participant’s contributions and earnings. The maximum loan amount a participant can borrow is the smallest of the following:

1. The participant’s own contributions and earnings on those contributions in the TSP account from which the participant intends to borrow (civilian or uniformed services), not including any outstanding loan balance;
2. 50 percent of the participant’s total vested account balance, including any loan balance, or $10,000, whichever is greater, minus any outstanding loan balance; or
3. $50,000 minus the participant’s highest outstanding loan balance, if any, during the past 12 months. Those participants who have both a civilian TSP account and a uniformed services TSP account, the combined account balances and outstanding loan amounts will be used to calculate the maximum loan amount for items 2 and 3.

When a participant has both a traditional TSP and a Roth TSP account and wishes to borrow from his or her TSP account, the loan is disbursed proportionately (according to the traditional and Roth TSP balances at the time of the loan application) from any traditional and Roth TSP balances in the two accounts.

Consider the following example:

On Aug. 1, 2012, James, a TSP participant, applies for a $10,000 TSP general purpose loan. As of Aug. 1, 2012, James’ traditional TSP account balance is $180,000 and his Roth TSP balance is $20,000. Of the $10,000 loan amount, $20,000/$200,000 or 10 percent ($1,000) will be disbursed from James’ Roth TSP account and $180,000/$200,000 or 90 percent ($9,000) will be disbursed from James’ traditional TSP account.

If a TSP participant is invested in more than one fund, then the loan will be disbursed proportionately from the participant’s contributions (and earnings on those contributions) that the participant has in each fund. This proportion is determined as of the date of the loan disbursement.

When a TSP loan is repaid, the payments (including interest) are deposited back into the traditional and Roth balances of the participant’s account in the same proportion used for loan disbursement. In the example above, if James’ biweekly repayment amount via payroll deduction is $100, $10 will be deposited back into James’ Roth TSP account and $90 will be deposited back into James’ traditional TSP account. The repayment amount is invested in a participant’s account according to the participant’s most recent contribution allocations.

The loan interest rate a participant pays for the life of the loan will be the G fund’s interest rate that is in effect on the date that the participant’s loan agreement is generated. With the G fund currently at perhaps its lowest annual rate over the past 25 years, (less than three percent), now would be an advantageous time for a TSP loan.

Other Important Information on Thrift Savings Plan Loans

• Spousal rights. In applying for a TSP loan, a participant must indicate whether he or she is married, even if separated from the spouse. A spouse of a FERS participant must formally consent to the spouse’s TSP loan by signing the TSP loan agreement. With a married CSRS TSP participant, the TSP must notify the participant’s spouse when the participant applies for a loan. Exceptions to the spousal written consent or notification may be approved under very limited circumstances. Both the TSP will pursue and refer to the Department of Justice for prosecution of any person who attempts to deprive a spouse of his or her TSP rights by forging the spouse’s signature, by lying about marital status, or by taking similar fraudulent actions.

• Court orders against a TSP account. Those participants who have a court order against their accounts, such as for those that enforce payment of child support or alimony, or that award a portion of their account to a former spouse, will not be able to get a TSP loan. When the TSP receives a court order, a hold is placed on the participant’s account. A loan cannot be obtained until the court order has been satisfied.

Applying for a TSP Loan

A participant can apply for a TSP loan in one of two ways:

(1) By electronic request through the TSP website, http://www.tsp.gov; or

(2) By paper request by downloading Form TSP-20, Loan Application. For a residential loan, the following documentation must be submitted with the loan: (1) Application to document the costs associated with the purchase or construction of a primary residence; (2) Written documentation from a third party showing the TSP participant or spouse as the purchaser or that the residence is being built for the participant; and (3) The purchase or construction price, the full address of the primary residence and the signatures of buyer and seller (contracts only).

The TSP will deduct a $50 fee from the proceeds of the loan to cover administrative costs. This fee will be deducted proportionately from any traditional or Roth TSP funds included in the loan amount. For example, if a participant applies for a $5,000 TSP loan, the TSP will deduct the $50 fee and the amount paid to the participant will be $4,950. A participant cannot send a personal check to the TSP to pay the loan fee.

Repaying a TSP loan

Regularly scheduled TSP loan payments are made through payroll deduction. When a TSP loan is disbursed, the TSP will notify the participant’s payroll office to immediately begin deducting loan payments from the participant’s balance each pay period. Participants with outstanding loans should be aware that:

1. They are responsible for ensuring that the correct loan payments are submitted on time. If, for any reason, a participant’s payroll office missed a loan repayment, the participant must pay the missed amount directly to the TSP using personal funds;
2. They can reamortize their loan at any time to change their payment amount or to shorten or length their loan term, provided they do not exceed the 5 year maximum term for a general purpose loan or the 15 year maximum term for a residential loan.
3. If, in the event a TSP participant with a current loan changes agencies or payroll offices, then the participant must inform their new agency or payroll office that they have a TSP loan and instruct the new agency or payroll office to continue the TSP loan payments.
4. They cannot suspend loan payments.
5. They can make additional loan payments to make up for missed payments. Payments are made with loan payment coupons, Form TSP-76.
6. They can prepay their TSP loans in full at any time without a prepayment penalty. Prepayments are made using a Loan Payment Coupon, Form TSP-20.

Taxable Distribution of TSP Loans

The TSP must declare a taxable distribution on the entire unpaid loan balance (including any accrued interest) of the loan if:

• The loan is in default — missed payments not made up within the required time);

• The loan is not paid back in full by the maximum term limit; or (3) The participant retires or separates from federal service and does not repay the loan in full.

When the TSP declares a taxable distribution, the IRS considers the unpaid balance of the TSP loan to be taxable income. In addition, a participant who is under age 59.5 may have to pay a 10 percent early withdrawal penalty tax. Once a taxable distribution has been declared, the loan is closed and the participant will not be allowed to repay it.

If any part of a TSP loan is associated with Roth contributions, those contributions (which were made with after-tax dollars) will not be subject to tax. But the following conditions apply to Roth earnings:

1. If the taxable distribution is declared because the participant separates from federal service, any Roth earnings that are not “qualified” (have been in the Roth TSP account for the later of five years since the Roth TSP participant made his or her first contribution and when the Roth TSP participant became age 59.5 or became disabled) will be subject to tax. However, Roth earnings that are “qualified” will not be subject to tax.
2. If the taxable distribution is declared for another reason (such as a default on one’s loan), the Roth earnings will be subject to tax, even if the participant has already met the conditions necessary for the participant’s earnings to be “qualified”.
3. A taxable distribution permanently reduces a participant’s account.
4. A taxable distribution will affect a participant’s eligibility for another TSP loan. A participant cannot apply for another TSP loan from that account within 12 months of the date of the distribution.

If a participant leaves or retires from federal service, the participant’s loan must be closed within 90 days of the date when the participant’s agency reports the participant’s separation to the TSP. The participant may: (1) Repay the loan in full; (2) Partially repay the loan, and receive a taxable distribution on the remaining outstanding balance; or (3) Receive a taxable distribution of the entire outstanding loan balance. Note that a TSP withdrawal request cannot be processed until a TSP loan has been closed.

In the event of a TSP participant’s death, any outstanding loan balance plus any unpaid interest is reported as a taxable distribution to the participant’s estate. The loan cannot be repaid by the estate or by the estate’s beneficiaries. The distribution is not subject to an early withdrawal penalty tax. However, traditional TSP loan amounts and nonqualified Roth TSP earnings will be included in the distribution and be subject to federal and perhaps state income tax.

What TSP Participants Need to Consider Before They Borrow from Their TSP Accounts

The TSP was designed to provide federal employees with income after they retire. The amount in a retiring employee’s TSP account depends on decisions the employee has made during his or her working years with the federal government or while serving in the uniformed services, namely: (1) How much they have contributed during their working years; (2) How they have invested their contributions; and (3) How much they have withdrawn from their accounts before they retired.

The TSP loan program is an important benefit that allows participants access to the money in their accounts. But taking a loan could result in less money at retirement. Before borrowing from their TSP accounts, TSP participants should consider the following:

(1) If a participant’s account is earning a higher rate of return than the interest rate on their TSP loan, then the participant will end up with a smaller TSP account than it would have been had the participant not borrowed from it.

(2) If the participant is unable to contribute as much to the TSP because of the financial burden of the loan payments, then the TSP account will not grow as much.

(3) A TSP residential loan is not a mortgage. As such, TSP loan interest payments are not tax deductible as home equity interest payments may be tax deductible.

(4) A TSP participant with a residential loan who leaves or retires from federal service must pay off the residential loan with 90 days of leaving or retiring from federal service. This is true even if the TSP participant remains in the primary residence.

Before taking out a TSP loan, TSP participants are encouraged to read the fact sheet: “The Cost of TSP Loans”, available on the TSP website, http://www.tsp.gov. In reading this fact sheet, a TSP participant should have a better understanding of the effect of a TSP loan on the participant’s future retirement income.

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• TSP Issues Updated Details on Temporary Loan and Withdrawal Options from CARES Act