Thread: TSP Loan and repayment with taxed income

Originally Posted by ChemEng

How does not taking the loan save you any tax money at all?

1) $100K pre-tax in TSP. You make a $25K loan at a bank and pay it back with after tax money. In retirement your $100K in TSP is taxed.

2) $100K pre-tax in TSP. You make a $25K loan from TSP and pay it back with after tax money so now your TSP has $75K of pre-tax money and $25K of after tax money. In retirement you are taxed on the $75K. Thats the first time the $75K has ever been taxed. The $25K that you paid the loan with has already been taxed once and now it will be taxed again in retirement.

I'm just a simple man who sticks mail in mail boxes for a living. If you can show me where I'm wrong in my reasoning I would really appreciate it.

Originally Posted by KevinD

1) $100K pre-tax in TSP. You make a $25K loan at a bank and pay it back with after tax money.

Originally Posted by KevinD

2) $100K pre-tax in TSP. You make a $25K loan from TSP and pay it back with after tax money

3) Loan is paid off. So at this point in the analysis, both loans are paid off using the same amount of pool of money taxed at exactly the same amount. Notice the situations are exactly the same here for both TSP and any bank loan.
4) Draw down during retirement. You now have 2 different situations
a. No TSP loans. Draw downs taxed at regular income levels.
b. With TSP loans. Draw downs taxed at regular income levels.

Both situations are again exactly equal regardless of if you take a TSP loan or if you take a bank loan.

Originally Posted by KevinD

I'm just a simple man who sticks mail in mail boxes for a living.

I'm a simple missile engineer. We all got things to learn from each other on here. That's the beauty of this forum.

You didn't address the difference between the $100K pre-tax distributions in retirement and the $75K pre-tax and $25K after tax distributions in retirement.

In scenario #2, if you had not made the TSP loan you wouldn't be taxed twice on that $25K.

Seems to me it would be similar to the basis of a deductible vs a non-deductible traditional IRA.

Sorry to be such a PITA but I'm trying to comprehend how I'm not being taxed twice on that $25K. That was the question in post #1 of this thread...

Originally Posted by KevinD

You didn't address the difference between the $100K pre-tax distributions in retirement and the $75K pre-tax and $25K after tax distributions in retirement.

In scenario #2, if you had not made the TSP loan you wouldn't be taxed twice on that $25K.

Seems to me it would be similar to the basis of a deductible vs a non-deductible traditional IRA.

Sorry to be such a PITA but I'm trying to comprehend how I'm not being taxed twice on that $25K. That was the question in post #1 of this thread...

Not a problem. Just to be clear--you agree with the analysis. You just want to specifically talk about the $25k, right? (I'm bouncing between airports today so it may not be until this evening that I get back to you.)

Yep. The taxes on the $25K.

IMO - No loan would be best but if you have to borrow money it would depend on the math comparing the difference in the rates on the 2 loans and the double taxation on the TSP loan. After all thats what this thread was about to begin with.

I got my answer and it only cost me $13.95.

http://www.fedtools.com/cgi-local/So...047+1221955341

Granted the following example is on a loan that has a 6% rate...

There are two negative aspects concerning TSP loans that should be addressed. When the TSP loan
proceeds are disbursed from a TSP account, the borrower loses the earnings—interest, dividends or capital
gains—that the withdrawn monies would have accrued during the time they are not in the account. The
money used to back the TSP loan is done with post-tax dollars and taxed again when withdrawn. TSP
participants contribute to their TSP accounts on a pre-tax basis; TSP borrowers use post-tax dollars to pay
back their accounts and pay tax again when the borrowed and paid-back amounts are withdrawn. This is
double taxation; however, most 401(k) plans in private companies use this procedure for participants who
take on 401(k) loans.

In terms of dollars and cents, consider the following example for the cost of a TSP loan. Biweekly payroll
allotments are $140.50, consisting of principal and 6 percent interest. The following amortization table
illustrates the breakdown of principal and interest of a TSP loan.

Therefore, in paying back the $10,000, an individual also would have paid a total of $938.51 in interest
which is not deductible for tax purposes and $10,000 of principal, for a total of $10,938.51.
Assuming the individual is in a 28 percent federal and a 7 percent state income tax bracket—for a
combined federal-state tax bracket of 35 percent—the individual must earn $10,938.51/0.65, or $16,828
in pre-tax dollars in order to end up with $10,938.51 in post-tax dollars. Once the individual withdraws
the $10,938.51 from his or her TSP account, it will be taxed again, perhaps at a higher tax rate.

Originally Posted by KevinD

I got my answer and it only cost me $13.95.

http://www.fedtools.com/cgi-local/So...047+1221955341

Granted the following example is on a loan that has a 6% rate...
Quote:
There are two negative aspects concerning TSP loans that should be addressed. When the TSP loan
proceeds are disbursed from a TSP account, the borrower loses the earnings—interest, dividends or capital
gains—that the withdrawn monies would have accrued during the time they are not in the account. The
money used to back the TSP loan is done with post-tax dollars and taxed again when withdrawn. TSP
participants contribute to their TSP accounts on a pre-tax basis; TSP borrowers use post-tax dollars to pay
back their accounts and pay tax again when the borrowed and paid-back amounts are withdrawn. This is
double taxation; however, most 401(k) plans in private companies use this procedure for participants who
take on 401(k) loans.

In terms of dollars and cents, consider the following example for the cost of a TSP loan. Biweekly payroll
allotments are $140.50, consisting of principal and 6 percent interest. The following amortization table
illustrates the breakdown of principal and interest of a TSP loan.

Therefore, in paying back the $10,000, an individual also would have paid a total of $938.51 in interest
which is not deductible for tax purposes and $10,000 of principal, for a total of $10,938.51.
Assuming the individual is in a 28 percent federal and a 7 percent state income tax bracket—for a
combined federal-state tax bracket of 35 percent—the individual must earn $10,938.51/0.65, or $16,828
in pre-tax dollars in order to end up with $10,938.51 in post-tax dollars. Once the individual withdraws
the $10,938.51 from his or her TSP account, it will be taxed again, perhaps at a higher tax rate.

Thank you for doing the research. The fruits of your efforts are crystal clear to me.

Here's another resource that covers part of this issure.
3 Considerations Before You Borrow From Your Thrift Savings Plan Account
http://www.myfederalretirement.com/public/130.cfm

http://www.myfederalretirement.com/p...partment46.cfm

I'm having trouble completely understanding the example regarding the $10k loan. Hopefully someone can show me the error in my thought process.
I understand the "double-tax" on the interest paid on a TSP loan. But I don't get how the principal repayment is "double-taxed".
For instance, in regards to the example:
What if the $10k that was borrowed was simply put aside and used to repay the loan? How is that amount being taxed twice, since you are not using taxed income to repay it?

Can someone explain what I'm missing here?

Ok from a different angle.

When you borrow $25k from a pretax account, you are increasing your relative purchase power for any posttax product. Think about that for a minute. So, assuming you are in a 25% tax bracket, that equals ~30% more buying power over using posttax dollars. When you repay that loan, you have to payback equal to that increased purchasing power plus interest. Repaying with posttax dollars is exactly equal to the amount of your increased purchasing power.

Originally Posted by KevinD

Yep. The taxes on the $25K.

IMO - No loan would be best but if you have to borrow money it would depend on the math comparing the difference in the rates on the 2 loans and the double taxation on the TSP loan. After all thats what this thread was about to begin with.

Originally Posted by ChemEng

Ok from a different angle.

When you borrow $25k from a pretax account, you are increasing your relative purchase power for any posttax product. Think about that for a minute. So, assuming you are in a 25% tax bracket, that equals ~30% more buying power over using posttax dollars. When you repay that loan, you have to payback equal to that increased purchasing power plus interest. Repaying with posttax dollars is exactly equal to the amount of your increased purchasing power.

But most people have no idea where the money went...especially when they are borrowing to pay off other debt. All they have to show for it is a hole in their wallet/account.

I agree with your premise but I'm afraid that reality is that most people just aren't that sophisticated. Many people have negative savings, negative equity in their car, negative equity in their home and balances on their credit cards. These people are Dave Ramsey and Clark Howard's audience. They're addicts. They have to go cold turkey or live chained to their debt and have to keep working till way onto their 70's. I'm not going to be one of those people.

Thanks for playing but I think this horse has had enough...

Originally Posted by ripper

I'm having trouble completely understanding the example regarding the $10k loan. Hopefully someone can show me the error in my thought process.
I understand the "double-tax" on the interest paid on a TSP loan. But I don't get how the principal repayment is "double-taxed".
For instance, in regards to the example:
What if the $10k that was borrowed was simply put aside and used to repay the loan? How is that amount being taxed twice, since you are not using taxed income to repay it?

Can someone explain what I'm missing here?

Then why make the loan in the first place?