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Key factors to consider when filing for bankruptcy with an outstanding TSP loan

There are many factors to consider when filing for bankruptcy with an outstanding TSP loan. Consider the following:

Your TSP loan cannot be made part of your bankruptcy estate. TSP funds are protected from the claims of creditors and “…may not be assigned or alienated and are not subject to execution, levy, attachment, garnishment or other legal process.” (5 U.S.C S 8347 (e) (g)).

Your TSP loan is not a debt. You are borrowing your own money and paying it back to your own TSP account. As it is not a debt, it cannot be discharged in bankruptcy.

You have to pay it back. Bankruptcy (both chapters 7 and 13) does not affect your obligation to repay your TSP loan.

If you stop making payments the TSP will close your loan. If you stop making payments on your TSP loan due to financial difficulties, the TSP will try to get you to bring your payments up-to-date. If you cannot do so, the TSP will close your loan and report the unpaid loan balance to the IRS as a taxable distribution to you. You will have to pay income taxes on the taxable amount of the distribution and, based on your age, may have to pay the 10% early withdrawal penalty as well.

Payments cannot be suspended. If you want to suspend loan payments, be aware that you will not be allowed to do so. The TSP is required to close the loan and issue a taxable distribution if payments do not continue under the terms of your loan agreement.

Financial hardship withdrawals limited. Bankruptcy might affect your ability to take a financial hardship in-service withdrawal. Chapter 7 bankruptcy does not affect your ability to take such a withdrawal, but chapter 13 limits your ability to take a financial hardship in-service withdrawal that is based on negative cash flow. Under chapter 13, you will still be able to take a financial hardship in-service withdrawal that is based on unpaid medical expenses, personal casualty losses or legal fees incurred tor a separation or divorce.