By Einat Steklov, for Kashable
Let’s face it, most of us don’t have the emergency savings that we know we should. Life gets expensive, and sometimes covering monthly expenses can be difficult. The problem with this is that far too often, when an unexpected expense arises, you may be forced to turn to your TSP account to bridge the gap.
Before sacrificing the future to make ends meet today, it you must fully understand the potential implications of TSP Loans and Hardship Withdrawals, as well as all other options available when you need financial assistance.
Below are some important points that all federal employees should be aware of when considering a TSP Withdrawal or Loan:
TSP Hardship Withdrawals
1. Financial hardship withdrawals are limited to four major financial hardships that are considered acceptable reasons:
○ Negative monthly cash flow
○ Medical expenses not covered by insurance
○ Personal casualty losses not covered by insurance
○ Legal expenses incurred for separation and divorce
2. You won’t be able to contribute to your TSP for 6 months from the time your hardship withdrawal is processed. No contribution means no matching contributions from the federal government. You will also lose any potential investment gains you could have earned on those contributions.
3. Unlike a loan, a financial hardship withdrawal will permanently deplete your TSP account. You will not be able to make extra contributions to catch up to the withdrawal amount, leaving you with less funds when you retire.
TSP General Purpose Loans
1. Single loan limit: Federal workers are only allowed one outstanding general purpose loan at a time. If you have already tapped your retirement plan, you may be left unprotected if an emergency occurs.
2. Administrative fee: There is a processing fee of $50 per loan, which is deducted from the loan amount.
3. Double taxation: When repaying a TSP loan, you pay that interest back to yourself; however, you’ll do it with after-tax dollars. Then, when you make a withdrawal in retirement, you’ll have to pay taxes yet again on the same funds.
4. Loss of potential earnings: Although you pay the loan amount back to your TSP with interest, the amount of interest paid may be less than what you might have earned if the money had remained in your retirement account.
To learn more about compound interest and calculate your potential earnings, visit: https://www.investor.gov/additional-resources/free-financial-planning-tools/compound-interest-calculator
5. Serious tax consequences for defaulted loans: Before taking a TSP loan, it is imperative that you ensure you will be able to make your payments. If you miss loan payments and your loan is in default, or you do not repay your loan in full by the maximum term limit (5 years), TSP must declare a taxable distribution to the IRS. Here’s what that means for you:
○ Your loan amount, including any accrued interest will become taxable income. That means you’ll have to pay income tax depending on which bracket you are currently in.
○ If you are under age 59 ½, you may have to pay an additional 10% tax penalty for early withdrawal.
○ Once a taxable distribution has been declared, the loan is closed and you will not be allowed to repay it.
○ A taxable distribution permanently reduces your TSP account. You will not be able to make additional contributions to cover the loan amount, leaving you with less funds when you retire.
○ You may not apply for another loan from your account within 12 months of the date of the taxable distribution.
6. Repayment when leaving Federal Service: If you leave federal service, your loan must be closed within 90 days of the date when your agency or service reports your separation. If you do not repay the loan within the required time frame, the TSP will declare a taxable distribution, meaning you will be liable for the serious tax consequences and penalties explained above.
In any case, federal employees must exercise due diligence before taking a TSP loan or hardship withdrawal and fully understand all options available to them. Research options that allow you to keep funds in your retirement account. Otherwise, you risk sacrificing your financial stability in retirement just to make ends meet today.
Einat Steklov is founder of Kashable, a financial wellness company that provides Federal Employees access to socially responsible, low-cost credit. Kashable can be used for any purpose, including paying down expensive debt or covering an unexpected expense.
For more information, visit www.kashable.com.