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Chapter 7 bankrutpcy and a TSP loan

Over the course of time, some Kentucky federal employees may decide to take out a loan against their Thrift Savings Plan (TSP). Such an action may provide the individual with the funds needed to meet an immediate need. However, it is important to remember that TSP loans are treated differently from other loans throughout the Chapter 7 bankruptcy process.

The TSP is designed to be a retirement savings account. As such, income tax on these funds are deferred until they are withdrawn from the plan. Additionally, if funds from the plan are received in the form of a loan, these funds are not considered to be withdrawn and are therefore not considered as taxable income at the time.

During the Chapter 7 bankruptcy process, the majority of an individual's debt can be discharged. However, when one borrows from a TSP account, one is essentially borrowing his or her own money. Thus, a TSP loan cannot be discharged as part of the bankruptcy process.

It may be tempting, or even necessary, to stop making payments on a TSP loan as one is struggling financially. If such payments are stopped, the TSP loan will be closed and will then be treated as a disbursement. This will result in the amount of the outstanding loan being reported as an early withdrawal for income tax purposes. While it may be necessary to cease making payments, the Kentucky resident will then possibly be confronted with unplanned taxable income in addition to an early withdrawal penalty. These items, along with the TSP loan, are generally excluded from the Chapter 7 bankruptcy.

Source: fedweek.com, "Key factors to consider when filing for bankruptcy with an outstanding TSP loan", Sept. 18, 2017

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