Don't rob your financial future

FCW's Friday Financials column covers the pros and cons of tapping into your Thrift Savings Plan account for emergency cash

It's mighty tempting. You've just been laid off, and money is tight. There sits your Thrift Savings Plan, plump from several years of good returns, even after the current market slide.

Resist the temptation to use it, says Dennis Filangeri, a certified financial planner based in San Diego. Taking money from your TSP account to pay immediate bills means robbing your financial future.

Before dipping into your TSP account for cash, explore alternatives. First, don't do anything hasty. You may get a new job more quickly than you think. Second, cut household expenses as much as possible.

If that doesn't bridge the gap between income and expenses, consider tapping into non-TSP financial sources such as taxable savings or money market accounts, cash-value life insurance, or taxable investments such as mutual funds or individual stocks or bonds. Weigh your options carefully before deciding, however. It might be better to borrow in some cases than to sell some investments.

After all this, your TSP account may still look appealing. But before tapping into it, keep these points in mind.

You have two ways to use TSP assets for an emergency: borrow, or take out money permanently on a financial hardship withdrawal. On permanent withdrawals, you will pay regular income taxes. You'll also likely pay a 10 percent early withdrawal penalty on the money if you are younger than 59 1/2. After making a financial hardship withdrawal, you cannot contribute to your TSP account for 6 months. If you are a Federal Employees Retirement System participant, you will not receive any agency matching contributions; but you will continue to receive agency automatic (1 percent) contributions. At the end of the six-month period, your contributions will not resume automatically. You must submit Form TSP-1 to your agency (you do not need to wait for an open season), and your contributions will then be allocated according to your most recent contribution allocation.

The obvious downside to taking out money permanently is that you can never put it back and the money can never again grow tax-deferred in the account to help pay for your retirement. This loss of tax-deferred growth could cost you thousands of dollars across the years. That's why borrowing is usually the preferable option if you must tap your TSP account. However, you will not be able to borrow from your TSP account after you've been laid off. You must be in pay status to obtain a loan, because you repay your TSP loan through payroll allotments. In fact, laid-off employees who leave federal service will be required to pay back any outstanding loans incurred before the layoff.

Assuming you have access to your or your spouse's plan, you can borrow no more than $50,000 of your contributions. With the exception of borrowing for a home, you must pay back the loan within one to four years in regular payments, at reasonable interest rates. That's one of the good features of borrowing from your own retirement account: you're paying the interest payments to yourself instead of another lender.

The big risk with borrowing is that if you fall behind on your loan payments — a distinct possibility if you are laid off — you could end up paying income tax on the portion of the loan that's not been repaid, plus that 10 percent penalty if you're younger than 59 1/2. This is because the Internal Revenue Service treats any amount still owed as an early distribution.

Even assuming you pay yourself back, you may still suffer what is known as an "opportunity cost." That means the investments in the account could have earned more money than the interest rate you are repaying yourself with. Furthermore, you're not really "earning" money paying yourself back. You're using your own cash-flow dollars that could have been invested elsewhere. You're also paying back the loan with after-tax dollars. When you withdraw that money years later for retirement, you'll pay tax on it — again!

This is not to say you should never borrow from your TSP account. Sometimes a financial emergency demands the need for prompt cash and you don't have good alternatives. However, before using your future retirement money, carefully consider all options and be sure you use the money only for emergency needs, such as meeting a house payment or uninsured medical expenses. Don't spend it on nonessentials such as entertainment or a new television.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at miltzall@starpower.net.

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