If you’re a federal employee or a member of the military, your retirement options are slightly different than your friends and neighbors in the private sector, but like everyone else, it’s worth planning ahead and knowing. the rules when it comes to your retirement.
If you’ve invested in a Savings Plan (TSP) for your retirement, you’ve hopefully invested as much as you can throughout your career – ideally by maximizing it, but contributing at least. 5% of your salary to take full advantage of it. government matching funds.
But it’s not yet time to congratulate you. If you are nearing retirement age, you still have some important planning to do. A potential pitfall for TSP investors? An unpaid TSP loan.
What is a TSP loan?
When you have a TSP account, you are allowed to take out a loan on your own investment. This is similar to borrowing against a 401 (k) 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 repaid within 5 years. A home loan must be used to buy or build a primary residence (i.e. your primary residence rather than a vacation home) and must be repaid 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. They’re also handy because you’ll be paying off the loan with payday deductions that come straight from your paycheck, so you never have to worry about missing a payment.
Retire with a TSP loan
If you’re nearing retirement age and still paying off a TSP loan, you need to do some extra planning. If possible, it is best to pay off your loan before retirement age.
If you want to retire before your loan is canceled, you can make additional payments by mailing a check in the mail along with a loan repayment coupon. You can pay a little extra each month, use your tax refunds to give yourself a boost, or pay off the balance all at once if you can afford it.
If you aren’t able to prepay your loan, don’t worry: you can still retire with an outstanding TSP loan. No one will force you to continue working until you have paid.
However, there are a few downsides to be aware of if your loan is past due on your retirement date.
The TSP is required by law to report any outstanding loan balances – 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 can’t pay the balance by then, you’ll have to pay income taxes – federal and state – at your regular rate on the outstanding balance and interest. Depending on the size of your balance, this could be a big tax trap that eats up your refund and could even cause you to owe a lot of the change in April.
Additionally, you may be subject to the IRS 10% early withdrawal penalty, unless you are 55 or older in the calendar year in which you leave federal service.
Some silver linings and additional details
If your TSP loan was made out of a Roth account, you may not have to pay income tax on all or part of the unpaid loan amount, although you may still owe a penalty if you have. under 55 years old. account is for income that was already taxed before you contributed to the retirement account. You cannot be double taxed on this income.
While some of your TSP contributions are traditional and others are Roth, the tax calculations quickly become complex. A good financial advisor will help you do the math and work out the details so you can avoid costly mistakes on your tax return the year you retire.
You can also transfer funds from your TSP to another IRA if you wish. To do this, you will still have to repay the loan, but you may be able to save a little extra time to do so. This is because you have an additional 60 days from the time the taxable distribution is declared (i.e. at the end of the 90 day grace period) to complete the rollover and pay the loan amount into your bank. IRA with other funds.
It’s important to note that these funds must have already been taxed, so you can’t just create a revolving door of working capital from various IRAs to get the job done.
Get the help and advice you need
Confuses? It’s understandable! The tax implications of an unpaid TSP loan can quickly become complicated.
This is why it is so important to speak to a knowledgeable financial advisor well before retirement. We’ll help you plan your TSP loan repayment to help you avoid the worst, and make sure all of your tax documents and forms are completed correctly to keep you from paying more than you should.
Need Help With Your Federal Employee Pension and Benefits? Contact us today to see how you can get the most from your investments and get the retirement you deserve.
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