Should You Borrow From Your 401(K) Or TSP?

Posted by Nick Niesen on November 8th, 2010

Conventional wisdom says that you should never, ever borrow from your 401(K). Financial gurus tell us that we should not take money out of our 410(K) for tax reasons and that many people do not have the self-control to pay back the loan.

With a Thrift Savings Plan (TSP), the government's version of a 401(K) it is a little bit different. Like the 401(K), you can take out a loan for 50% of your balance. The differences are that you have 2 different types of loans to choose from and you are forced to pay it back.

The two different types of loans are either personal or for a primary residence. The personal loan has to be paid back within 5 years and the loan for your primary residence has to be paid within 15 years. It must be the primary residence.

There are a couple of things I like about this. I can take out the personal loan and still use it for a residence that is not my primary. And, all I have to do is fill out a one-page form and send it online or fax it, and I will have a check in 10-14 days. I looked into taking out a home equity line of credit (HELOC) and the amount of forms was ridiculous, credit checks, and about $8,000 in fees.

I also like the low interest rate. It is currently at 4% (30 Jan, 2008) which was 2 percentage points lower than the HELOC. I will be borrowing the money from myself and paying myself back with a 4% premium.

The key to this type of loan with the government retirement program is that, once I take the loan, the payments will automatically be deducted from my paycheck the next pay period. This will be the forced self-control. I have to pay it back, it is a payroll deduction.

I do have to pay a $50 fee for processing the paperwork. That is minor compared to $8,000 for the HELOC.

Granted, you want to look at other ways of borrowing money and compare the present and future costs of all plans. As of June 2006, there were 750,000 outstanding loans totaling more than 5 billion dollars.

So, I am not the only one borrowing money for a house, college, or some other major project. I may lose a little in tax advantages, my TSP fund will be cut in half for a while, and it will take a few years to get my retirement fund back to "normal".

Borrowing from a 401(K), without being forced to pay it back, is the reason that most financial planners say that borrowing from your retirement fund is a loan of last resort.

The automatic payroll deduction to my retirement account was the key that convinced me that I would borrow from my TSP. The low interest rate and simple application helped too.