TSP Loan and repayment with taxed income

[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?

 

[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.

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.

 

[KevinD]

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...

 

[KevinD]

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?

 

[Show-me]

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?

I like this one. You use the money to trade with in a Roth and then use the principle to supplement income for the amount with held from TSP loan repayment.

No double tax there and you get the interest instead of the bank.

Or you repay the loan with a tax return.

No double tax there and you get the interest instead of the bank.

The main point is that you WILL pay take on any loan from any lender, so who cares if you pay tax on money you borrow from yourself. The upside is the bank don't get the interest, you do. The instrest will get paid no matter who you get the loan from.

Zero interest credit card are evil and if you make one payment error or it gets lost, you will pay all the back interest and have a new rate of 30% APR.

 

[ChemEng]

I agree with your premise

Then we are done.

Debt is simply a tool. You can choose to apply it to maximal effect like a hammer striking down a nail. Or you can choose to use it wrongly like trying to use a hammer to screw down a bolt. The bottom line is even if most people try to use the hammer to do the latter, it doesn't make the hammer any worse a tool. And to advocate not using hammers because people aren't smart enough to not use them to screw down bolts is crazy talk.

At some point we have got to get away from this lowest common denominator mentality in our culture. Mediocrity is very un-American.

 

[ripper]

Then why make the loan in the first place?

Obviously, no one would do this. I was merely trying to present an example of my thought in a simple form.
I just couldn't understand the example that stated that it would cost over $16k of earned income to repay a $10k TSP loan, especially when used for investing.
A couple of years ago I took out a loan for $20k for what I thought was a good investment opportunity that I couldn't pass up. I nearly doubled my investment in one year and paid off my loan.
According to the example, that loan cost me over $10k in earned income above what I borrowed. I still fail to see where that was the case.
I'm planning on taking out another loan for investment purposes. With its restrictions, the TSP is about the worst investment opportunity available. I think that the majority of the folks on this board could do much better with unlimited trading opportunities in all aspects of the market.
I only contribute to my TSP account for the matching funds. The tax deferment means little to me, as I estimate that I will be in the same tax bracket when I retire in five years.
If taking out a loan for investing is a bad idea, I wish someone would explain why.

 

[Prozium]

On further research, I agree with you.

Employees can also borrow money from their own TSP accounts at market-based interest rates through the TSP's loan program — loan amounts are not taxable if they are repaid to the TSP account on time.
http://www.fbijobs.gov/333.asp

 

[Prozium]

Loan interest rate: 2.125%
Sure thing G fund: 3.75%

To break even 5.875%. That is sure hard to do lately.

 

[ripper]

Loan interest rate: 2.125%
Sure thing G fund: 3.75%

To break even 5.875%. That is sure hard to do lately.

I believe the G fund return is equal to the loan interest rate....

 

[Show-me]

Isn't the G fund return equal to the loan interest rate?

Yes.

 

[KevinD]

If taking out a loan for investing is a bad idea, I wish someone would explain why.

I think we have determined that...

Debt is simply a tool.

I want to hear about...

A couple of years ago I took out a loan for $20k for what I thought was a good investment opportunity that I couldn't pass up. I nearly doubled my investment in one year and paid off my loan.

Care to share?

 

[ChemEng]

I want to hear about...

What exactly?

 

[Prozium]

Yes.

G fund - 12 month - 3.75%
http://www.tsp.gov/rates/monthly-current.html

Current loan interest rate - 2.125%
http://www.tsp.gov/calc/loan/calculate.html

Which means if you take a loan you need to get a return of at least 5.875% to break even.

 

[Show-me]

G fund - 12 month - 3.75%
http://www.tsp.gov/rates/monthly-current.html

Current loan interest rate - 2.125%
http://www.tsp.gov/calc/loan/calculate.html

Which means if you take a loan you need to get a return of at least 5.875% to break even.

The 12 month rate and the G fund current rate are two different dogs.

What will the interest rate be?
The interest rate you pay for the life of the loan is the latest available interest rate for the G Fund at the time your application is processed. The interest you pay on the loan will go into your TSP account, along with repayments of the loan principal. Visit Current Information on this Web site or call the ThriftLine to find out the current interest rate for TSP loans. Also, if you use the Loan Calculator on this Web site, the calculator will use the current rate automatically.

 

[KevinD]

What exactly?

rippers deal where he doubled his money.

I'm here to learn and boy am I getting schooled.

 

[ChemEng]

That the right attitude to have.

We all start at the beginning Kevin. Just keep trying to make sense of things for yourself. Keep asking why until either it makes sense to you or they change their stance (or stop answering ).

rippers deal where he doubled his money.

I'm here to learn and boy am I getting schooled.

 

[KevinD]

I may need some stinkier bait...

 

[roskopfm]

Another item you need to take into considering is the double taxation on the interest expense. Say you borrow 10,000 and pay it back plus 500 in interest. The 500 was already taxed out of your pay check. When you deposit it in the TSP you dont get a deduction. Then down the road if you withdraw that 500 it will get taxed again. Doesnt seem fair.

 

[ChemEng]

Here we go again. Please read back through the thread one more time. The amount of interest you pay back is exactly equal to the increased purchasing power you obtained from taking out the loan from the TSP. That sounds very fair.

Another item you need to take into considering is the double taxation on the interest expense. Say you borrow 10,000 and pay it back plus 500 in interest. The 500 was already taxed out of your pay check. When you deposit it in the TSP you dont get a deduction. Then down the road if you withdraw that 500 it will get taxed again. Doesnt seem fair.