Taking out a TSP loan to fund Roth IRA

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supersharpie
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Taking out a TSP loan to fund Roth IRA

Post by supersharpie » Thu May 21, 2015 9:33 pm

Due to some unanticipated expenses it is doubtful that my wife and I will be able to max out both our tradtional 401ks and Roth IRAs. I place a higher value on fully funding the Roth since we plan to retire by the age of 50 and know that we can withdrawal our contributions without penalty until we hit 59.5. With that said, I want to continue to max out our 401ks because tax advantaged space should not be left on the table.

My thought is to take out a 1 year $11,000 TSP loan at 2% towards the end of the year to fully fund our Roth IRA while still maxing out out our 2015 401k tax advantaged space.

The alternatives are to keep the money in the 401k and forfeit funding the Roth IRA this year or to significantly reduce our current TSP/401k contributions and fail to max out this year. Please explain how either of those options is preferable to my proposal.
Last edited by supersharpie on Thu May 21, 2015 9:39 pm, edited 1 time in total.

gclancer
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Re: Taking out a TSP loan to fund Roth IRA

Post by gclancer » Thu May 21, 2015 9:37 pm

I think that's a fine idea, so I'll leave the naysaying up to others. The only thing I have to offer is that maybe you should consider borrowing $22K and funding your 2015 and 2016 Roth IRAs at the same time (January 2016). Also, since the interest rate is the same regardless, why not opt for the 5-year amortization? You can always prepay when money frees up. The $22K loan would be counted as a bond allocation within your TSP.

kjvmartin
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Re: Taking out a TSP loan to fund Roth IRA

Post by kjvmartin » Thu May 21, 2015 9:43 pm

Couldn't you just take the hypothetical 401k loan payment and make that toward your Roth IRA every payday?

I vote no for 2 reasons:

#1. You're taking money that you can't touch without a penalty to add to a retirement fund you can pilfer at will.

#2. You can't beat the expense ratios on the TSP. You'll borrow from a super cheap plan to invest in one that likely will cost more.

Two Headed Mule
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Re: Taking out a TSP loan to fund Roth IRA

Post by Two Headed Mule » Fri May 22, 2015 7:32 am

This is exactly the kind of situation where a 401(k) loan can be of great value. A temporary expense prevents fully utilizing your retirement space, so you borrow to prevent losing the space and pay the loan back once the cash flow issue disappears. Any type of low interest loan would be fine here, including a HELOC. The idea only works, though, if you can continue to max out your retirement accounts while you pay back the loan. Otherwise, you aren't preserving that space.

Mule

supersharpie
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Re: Taking out a TSP loan to fund Roth IRA

Post by supersharpie » Sat May 23, 2015 2:58 pm

Thanks for the feedback! We still haven't decided how to proceed but this is good food for thought.

retiredjg
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Re: Taking out a TSP loan to fund Roth IRA

Post by retiredjg » Sat May 23, 2015 3:08 pm

I vote no. It sounds like robbing Peter to pay Paul.

But you could reduce your TSP contributions enough to put money into Roth IRA. That would accomplish what you want. Or you could simply put $11k into Roth TSP.

Or if this is a one time thing, just don't worry about it. If an $11k contribution is the difference between successful early retirement and unsuccessful early retirement, you are cutting it too thin anyway.

DSInvestor
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Re: Taking out a TSP loan to fund Roth IRA

Post by DSInvestor » Sat May 23, 2015 3:16 pm

I vote no. The deadline for 2015 Roth IRA contributions is April 15, 2016. That gives you some breathing room to rebuild your emergency cash reserves and/or save for your Roth IRA contributions.

If you're planning on retiring at age 50, are you also contributing to taxable accounts or have investments in taxable accounts? If you have investments in taxable accounts, collect those dividends from those investments and use them to contribute to Roth IRA. If you qualify for the 0% LTCG tax rate, it may be better to realize a little bit of LTCG and then use those sales proceeds plus collected dividends to contribute to Roth IRA.

Are there any expenses that you can reduce to improve you cash flow? cable bill, cell phone plan, auto insurance, dining out, stopping extra mortgage principal payments etc.

supersharpie
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Re: Taking out a TSP loan to fund Roth IRA

Post by supersharpie » Sat May 23, 2015 3:21 pm

retiredjg wrote:I vote no. It sounds like robbing Peter to pay Paul.

But you could reduce your TSP contributions enough to put money into Roth IRA. That would accomplish what you want. Or you could simply put $11k into Roth TSP.


Well, the thing is that we want to continue maxing out our TSP and 401k tax deferred space while also maxing out our Roth IRAs. Reducing our 401k/TSP contributions to fund the Roth means we lose that space forever whereas by taking out a loan and paying it back we will only lose it temporarily.

With that said, I realize that long term the 11k contribution will not have a significant impact on our ability to retire early.

supersharpie
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Re: Taking out a TSP loan to fund Roth IRA

Post by supersharpie » Sat May 23, 2015 3:26 pm

DSInvestor wrote:I vote no. The deadline for 2015 Roth IRA contributions is April 15, 2016. That gives you some breathing room to rebuild your emergency cash reserves and/or save for your Roth IRA contributions.

If you're planning on retiring at age 50, are you also contributing to taxable accounts or have investments in taxable accounts? If you have investments in taxable accounts, collect those dividends from those investments and use them to contribute to Roth IRA. If you qualify for the 0% LTCG tax rate, it may be better to realize a little bit of LTCG and then use those sales proceeds plus collected dividends to contribute to Roth IRA.

Are there any expenses that you can reduce to improve you cash flow? cable bill, cell phone plan, auto insurance, dining out, stopping extra mortgage principal payments etc.


We are significantly curbing our expenditures on dining out, travel, and other non-essentials for the rest of the year.

We have not been investing in taxable accounts yet but should be in a position to do so in 2019 after we finish paying off my wife's student loans. We will likely engage in taxable investing for 15 years before retiring.

retiredjg
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Re: Taking out a TSP loan to fund Roth IRA

Post by retiredjg » Sat May 23, 2015 3:43 pm

supersharpie wrote:We have not been investing in taxable accounts yet but should be in a position to do so in 2019 after we finish paying off my wife's student loans. We will likely engage in taxable investing for 15 years before retiring.

You have 15 years where you expect to fill 2 work plans and 2 IRAs and also contribute to taxable for retirement. I realize that something has interrupted your intentions, but do you realize it probably will not matter?

I seriously doubt it will hurt you to borrow from the TSP. But I don't it will help in any meaningful way either. So why bother?

Two Headed Mule
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Re: Taking out a TSP loan to fund Roth IRA

Post by Two Headed Mule » Sun May 24, 2015 8:31 am

supersharpie wrote:
retiredjg wrote:I vote no. It sounds like robbing Peter to pay Paul.

But you could reduce your TSP contributions enough to put money into Roth IRA. That would accomplish what you want. Or you could simply put $11k into Roth TSP.


Well, the thing is that we want to continue maxing out our TSP and 401k tax deferred space while also maxing out our Roth IRAs. Reducing our 401k/TSP contributions to fund the Roth means we lose that space forever whereas by taking out a loan and paying it back we will only lose it temporarily.

With that said, I realize that long term the 11k contribution will not have a significant impact on our ability to retire early.


Your reasoning is sound. If unused contribution space carried over each year, this wouldn't be an issue. But since it doesn't, years of low income (or high expenses) 'wastes the space' even though, cumulatively over a number of years, you could easily max out the accounts. The loan idea (whether 401(k) or otherwise) is the closest thing there is to mimicking the effect of allowing the unused contribution space to carry over to higher income years. The loan in a sense reserves the space, while the contributions are then funded in the future when you have the higher cash flow. This issue is often faced by high income parents of young children in HCOL areas who have immediate cash flow issues but who can see a year or two down the road when the nanny and preschool are behind them.

The plan is close to risk free too. In the unlikely event you are fired, and no other funds are available, you simply withdraw those (same) contributions tax free from the roth and recontribute them to the TSP to pay off the loan.

Effectively what you are doing when the smoke clears is exchanging $11,000 in a taxable account for $11,000 in a roth. A fair generic estimate is that $11,000 in a roth for a relative youngster is worth something on the order of $13,500 in a taxable account (that is, you'd be indifferent between the choice of the two). So the transaction has an expected $2,500 present value benefit. That's a relatively small benefit to be sure, but it also doesn't require much work or risk. You can decide for yourself how to weigh those tradeoffs.

Mule

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Archie Sinclair
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Re: Taking out a TSP loan to fund Roth IRA

Post by Archie Sinclair » Sun May 24, 2015 8:44 am

Instead of a Roth IRA, why not make a Roth TSP contribution?

MnD
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Re: Taking out a TSP loan to fund Roth IRA

Post by MnD » Sun May 24, 2015 9:06 am

supersharpie wrote:Well, the thing is that we want to continue maxing out our TSP and 401k tax deferred space while also maxing out our Roth IRAs. Reducing our 401k/TSP contributions to fund the Roth means we lose that space forever whereas by taking out a loan and paying it back we will only lose it temporarily.

With that said, I realize that long term the 11k contribution will not have a significant impact on our ability to retire early.


Seems like you've created this artificial construct of having to max out 401K and Roth or IT WILL BE LOST FOREVER as your primary planning driver.
You even identify that this loan idea will not have a significant impact.

We've "wasted" gobs and gobs of this space over the decades and are on track to retire relatively early and right when we want to (mid-50's) with an expected financial lifestyle around 135% of current and we are not currently even remotely frugal.

I'd suggest you pay attention to bigger picture issues of balancing life needs and wants now along with steady progress towards retirement savings versus some overriding concern fear of "wasting tax space that will be lost forever oh NOOOOOOO.....".

pkcrafter
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Re: Taking out a TSP loan to fund Roth IRA

Post by pkcrafter » Sun May 24, 2015 10:23 am

supersharpie:
Due to some unanticipated expenses it is doubtful that my wife and I will be able to max out both our tradtional 401ks and Roth IRAs.

Right, and due to unanticipated expenses you may not be able to pay back the TSP loan. Sounds like you do not have an emergency fund.

My thought is to take out a 1 year $11,000 TSP loan at 2%

Would you be willing to invest in TSP if the expense ratios were 2%?

Never take a loan on any tax deferred investment unless it's an absolute emergency. If you want Roth funding that bad, reduce contributions to the TSP.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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M_to_the_G
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Re: Taking out a TSP loan to fund Roth IRA

Post by M_to_the_G » Sun May 24, 2015 10:19 pm

It's probably not a good idea to come up with a risky scheme to try to maximize accounts... if one simply doesn't have the money for it. A better solution might be to try budgeting to see where one can save a few more thousands of dollars that could be put toward a Roth IRA.
"It’s basically the plot of 'Charlie and the Chocolate Factory.' If you stick around, doing nothing, while everyone around you ****s up, you’re going to win big." - John Oliver

Youngvestor
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Re: Taking out a TSP loan to fund Roth IRA

Post by Youngvestor » Sun Nov 20, 2016 9:30 am

I was just thinking about this very topic but for one main reason that does not seem to be mentioned here. First I'd like to apologize for posting on a topic that was discussed last year.

I was thinking of making a similar maneuver, but I wanted to do it because I am reasoning that if I take out the 5k from the TSP and max out the Roth for the year than I would I be skipping out having the money I'm contributing to the Roth as "post tax" money because a tsp loan isn't taxed unless you are unable to pay it and only than counts as a taxable distribution? Essentially funding your Roth with pretax money and saving 20-30 percent depending on what tax bracket you fall into?

Is there something I'm missing here? Thank you for your time.

retiredjg
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Re: Taking out a TSP loan to fund Roth IRA

Post by retiredjg » Sun Nov 20, 2016 10:53 am

Welcome to the forum. This is not a good idea.

It does not work out like you think. While the $5k is no longer in your TSP, it is not making money in the TSP so your TSP is growing slower than it would if you leave the money there. That loss is not "made up" by the money being in Roth.

If you want to have a Roth IRA, you need to save some money and put it in Roth IRA, not steal from the TSP. :happy

TIAX
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Re: Taking out a TSP loan to fund Roth IRA

Post by TIAX » Sun Nov 20, 2016 11:04 am

Youngvestor wrote:I was just thinking about this very topic but for one main reason that does not seem to be mentioned here. First I'd like to apologize for posting on a topic that was discussed last year.

I was thinking of making a similar maneuver, but I wanted to do it because I am reasoning that if I take out the 5k from the TSP and max out the Roth for the year than I would I be skipping out having the money I'm contributing to the Roth as "post tax" money because a tsp loan isn't taxed unless you are unable to pay it and only than counts as a taxable distribution? Essentially funding your Roth with pretax money and saving 20-30 percent depending on what tax bracket you fall into?

Is there something I'm missing here? Thank you for your time.


When you pay back the TSP loan, it will be with post-tax money.

Youngvestor
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Re: Taking out a TSP loan to fund Roth IRA

Post by Youngvestor » Sun Nov 20, 2016 1:02 pm

Two points I overlooked. Thanks for the informative replies.

retiredjg
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Re: Taking out a TSP loan to fund Roth IRA

Post by retiredjg » Sun Nov 20, 2016 1:51 pm

Younginvestor, Just as a general statement, there are very few shortcuts in investing. It pretty much has to be done the old fashioned way by saving a reasonable amount of money and investing it in an allocation you can stick with when times get bad.

This will probably be a more conservative allocation than you want in the good times, :( :happy , but that is the way it is.

Since it is not possible to switch back and forth reliably (in fact, most attempts fail horribly), you just have to find a balance that is good enough for the good times and not too bad in the bad times. And don't fall for the TSP schemers either - the ones who say that you should move money to C fund this week and move to the G fund the week after that. It just does not work.

Be cautious of borrowing to invest, get rich schemes, the "great deal" that someone knows about, the surefire way to know when the market is going up or down, and anything that seems too good to be true. These are almost always a losing proposition.

Just save your money and give it time to do what it does.

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grabiner
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Re: Taking out a TSP loan to fund Roth IRA

Post by grabiner » Sun Nov 20, 2016 9:37 pm

Youngvestor wrote:I was just thinking about this very topic but for one main reason that does not seem to be mentioned here. First I'd like to apologize for posting on a topic that was discussed last year.

I was thinking of making a similar maneuver, but I wanted to do it because I am reasoning that if I take out the 5k from the TSP and max out the Roth for the year than I would I be skipping out having the money I'm contributing to the Roth as "post tax" money because a tsp loan isn't taxed unless you are unable to pay it and only than counts as a taxable distribution? Essentially funding your Roth with pretax money and saving 20-30 percent depending on what tax bracket you fall into?


Here's how I work out the math to see that this doesn't work out. For simplicity, I'll assume that your TSP loan is a one-year loan with all interest paid at the end; it is actually paid monthly. Also, for a fair comparison, the loan will be taken from the G fund. While your loan is taken prorated across all your accounts, you can reallocate your TSP at any time, so that you keep the same amount in stock.

The G fund rate is assumed to be 2%, and your tax rate 25%.

Scenario A:Contribute $7333 less to the TSP to put $5500 in the Roth TSP. Next year, you will have $7480 less in the traditional TSP and $5610 more in the Roth TSP. This is a good deal if you prefer Roth money to traditional money, and a bad deal if you prefer traditional.

Scenario B: Contribute $7333 less to the TSP to put $5500 in a Roth IRA. This is equivalent tax-wise to Scenario A as long as you don;t lose a match.

Scenario C: Take a $5500 loan to put $5500 in the Roth IRA. The loan balance grows to $5610, and your payment is after-tax, so it will cost $5610 to pay it off; this is $7480 pre-tax that you would otherwise be contributing to the TSP. Next year, you will have $7480 less in the TSP, minus any loan fee and the same Roth balance as Scenario B.

Thus Scenario C is no better than Scenario B, and you lose the loan fee, and the potential tax bill if you leave the government. In addition, Scenario C endangers your match next year if you can't afford to both pay back the loan and contribute enough for a match. Thus, I prefer Scenario B if it doesn't cost you a match, and Scenario A if you prefer Roth but need to stay in the TSP to keep the match.

The key factor is that it doesn't matter whether you are taking a TSP loan from traditional or Roth balances, because the loan works the same either way with the interest rate equal to the G fund rate. You borrow $5500, and pay back $5610 the next year, and your TSP balance is the same whether you took the loan or not.
David Grabiner

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