I Won't Use TSP/401(k) Loans If I Can Make THIS%
Updated: Dec 27, 2019
Retirement loans are like a loan to yourself...so why wouldn't I use them?
One Person's Trash is Another Person's Treasure
I recently found myself going over notes from another retirement benefits seminar with a friend when we stopped for a moment on TSP Loans. I quickly dismissed the idea of using them having done the "envelope math" time and time again. However, this time my friend reminded me that situations are dependent on the person and whereas it might not work for me in my situation it could be wildly beneficial for someone else in a different situation. So I dove into the math. You can find the excel sheet for your own analysis on our new Tools page here.
"Situations are dependent on the person and whereas it might not work for me in my situation it could be wildly beneficial for someone else in a different situation."
Mortgage V.S. Less Mortgage + TSP Loan
One use of a TSP loan is a home purchase. Let's examine two options to study. Either completely use a mortgage for a first home or using mostly mortgage and some TSP loan. The logic is that the TSP loan allows you to pay yourself back with interest and I can see why that'd sound enticing to most people. This is the situation that I've always dismissed as a bad idea.
I've calculated that if a retirement account and what can be made outside of the account exceeds 2.16% then completely using a mortgage would be a better choice. With that said, there are a number of variables to consider that may skew the results from person to person. Fortunately, we have provided an excel file for you to use as a backbone on our Tools page. On your own analysis be aware of these factors:
Taking a mortgage out allows your retirement account to continue to compound
The interest you pay on your mortgage is tax deductible and the money saved can be invested
TSP loans require a fee, albeit small, it compounds, and is worth noting
*The variables are shown below the Disclosure
To the Benefit of Mental Models
But alright, so my quick math was correct, but was I right to use a blanket message? Nope. Not ever. Let's examine a situation where a TSP Loan could be beneficial. Below is the same math but for either paying off credit card debt normally, or using a TSP Loan to cover it.
**The variables are shown below the Disclosure
As you can see in this credit card example the TSP is more beneficial to use no matter the level of opportunity cost up to 10%. Does that mean I'd recommend it? By practicing the "situation dependent" lesson again I would say it depends. There are people this would work wonders for and there are people that, without changing their habits, would rack up credit card debt in interim and would be left with credit card debt and a tsp loan. There's also the risk of losing a job and having to pay the TSP Loan back in an extremely fast amount of time as well. So as always, do your due diligence and as you sow, so shall you reap.
As an Amazon Associate I earn from qualifying purchases. I also would never recommend something that I, myself, would not do and can genuinely say that there is great value in these recommendations.
* 15 Year Mortgage Interest Rate: 3.23%
** Credit Card Interest Rate: 26%
*/** G Fund Interest Rate: 1.88%
*/** Federal Tax Rate: 28%
*/** State Tax Rate: 8%
*/** Principal: $20,000
*/** TSP Loan Fee: $50