Borrowing From Your 401(k): How a 401(k) Loan Works and When It Makes Sense
Key points
A 401(k) loan lets you borrow from your own retirement account and pay yourself back with interest. Not every plan offers one.
You can generally borrow up to 50% of your vested balance, up to $50,000, and repay it within five years through regular payments.
There's no credit check, and the interest goes back into your own account. But the money you borrow stops being invested while it's out.
The biggest risk is leaving your job. An unpaid balance can become a taxable distribution, plus a 10% penalty if you're under 59½.
A 401(k) loan can be a reasonable tool for a short, specific need you're confident you can repay. It's a poor fit for ongoing spending or when your job feels uncertain.
I took a 401(k) loan when I was buying my primary home. I used it for the deposit when I made an offer. I didn't want to sell investments in my taxable brokerage account, because I'd have had to pay a large capital gains tax, and I wanted to avoid it.
A 401(k) loan sounds like the perfect deal: you borrow from yourself, skip the credit check, and pay the interest to your own account. Sometimes it really is a reasonable choice. But it has costs that aren't obvious at first, and one risk that catches people off guard: what happens if you leave your job before it's repaid.
Here's how a 401(k) loan works, what it actually costs, and how to think about whether it fits your situation.
How a 401(k) Loan Works
A 401(k) loan isn't a withdrawal. The plan lends you money from your own vested balance (the part of your account that's yours to keep), and you repay it, with interest, back into your account.
Your plan has to offer it. Loans are optional for plans, and IRAs can't offer them at all (IRS). Some plans set stricter limits than the law requires.
How much you can borrow. The lesser of 50% of your vested balance or $50,000. If 50% of your balance is less than $10,000, a plan can let you borrow up to $10,000 (IRS). For example, with $80,000 vested, you could borrow up to $40,000; with $120,000 vested, up to $50,000. If you had another loan in the past 12 months, the $50,000 cap is reduced by recent loan activity.
How you repay it. In substantially level payments, at least quarterly (IRS). Most plans take payments straight from your paycheck.
How long you have. Generally five years. Plans can allow a longer term for a loan used to buy your main home (IRS).
Interest. The plan sets a rate, and the interest you pay goes back into your own account, not to a bank.
No credit check. Because you're borrowing your own money, there's no credit application, and the loan generally isn't reported to credit bureaus. Confirm with your plan.
Some plans charge a fee to set up or maintain a loan. Check your plan's loan policy, in its summary plan description, for its rate, fees, and limits.
What It Actually Costs
The interest you pay goes to yourself, so the loan can look free. It isn't. There are two real costs.
The money stops growing
While the money is out of your account, it isn't invested. You earn the loan's interest rate on it, not market returns. Whether that costs you depends on the market while the loan is out: in a strong market the gap can be large, and in a weak one it can work in your favor.
The interest is paid with after-tax money
You repay the loan from your take-home pay, which has already been taxed. In a pre-tax 401(k), the interest you pay back will be taxed again when you eventually withdraw it in retirement. That double taxation applies only to the interest, not to the amount you borrowed, so it's usually a smaller cost than it sounds. If the loan comes from Roth 401(k) money, the repaid interest goes back into the Roth part of your account, where qualified withdrawals are tax-free, so it isn't taxed again.
When a Loan Becomes Taxable
A 401(k) loan stays tax-free only while you repay it on schedule. Two things can turn it into a taxable "distribution," meaning money treated as if you had withdrawn it from the account.
If you leave your job
This is where most 401(k) loan problems start. If you leave your job, whether you quit, get laid off, or are fired, the plan may require the remaining balance to be repaid. If you don't repay it, the plan reduces your account by the unpaid amount. That's called a loan offset, and it's treated as a distribution: taxed as income, plus a 10% penalty if you're under 59½ and no exception applies, such as leaving your job in or after the year you turn 55 (IRS).
There is a cushion. If the offset happens within 12 months after you leave your job, it's a "qualified plan loan offset," and you have until your tax filing deadline for that year, including extensions, to put the same amount into an IRA or another plan and avoid the tax (IRS). That still means coming up with the cash, which can be hard in the same year you lost a job. Some plans let former employees keep repaying, so check your plan's rules. I cover this in more detail in What to Do With Your 401(k) When You Leave a Job.
Here's an illustrative example. Say $20,000 of your loan is unpaid when it's offset, you're in the 22% federal bracket (IRS), you're under 59½, and you don't roll it over. That's $4,400 in federal income tax plus a $2,000 penalty, before state tax, and the extra income could push part of it into a higher bracket. The offset is reported on Form 1099-R, which the plan sends you after the year ends.
If you miss payments
If you fall behind and don't catch up within the grace period your plan allows, the unpaid balance becomes a "deemed distribution." You're taxed as if you'd withdrawn it, plus a 10% penalty if you're under 59½, but you still owe the loan to the plan (IRS). Unlike a qualified plan loan offset, a deemed distribution can't be rolled over to avoid the tax. Because payments usually come straight from your paycheck, this is less common while you're employed. It becomes a real risk during unpaid leave or a payroll change.
The Pros and Cons, Side by Side
Pros | Cons |
|---|---|
No credit check, and generally not reported to credit bureaus | The borrowed money isn't invested while it's out |
Interest goes back into your own account | Interest is repaid with after-tax money and, in a pre-tax account, taxed again later |
Can cost less than high-interest credit card debt | Leaving your job can turn the balance into a taxable distribution |
Payments come straight from your paycheck | Missed payments become a taxable distribution |
Not taxed or penalized if repaid on schedule | Not every plan offers loans, and some charge fees |
Sources: IRS, Retirement topics: loans; IRS, Plan loan failures and deemed distributions; IRS, Plan loan offsets.
Other Options to Compare
A 401(k) loan is one way to get cash. Before taking one, it helps to compare the options.
Options that don't touch your retirement savings:
Your emergency fund. This is exactly what it's for. If you don't have one yet, I cover how to build it in Part 2: The Foundation: Your Emergency Fund & Debt-Free Numbers.
Selling taxable investments. Selling investments in a regular brokerage account doesn't touch your retirement savings, but if they've grown, you'll owe capital gains tax on the gain (IRS).
Other borrowing. A low-rate personal loan may cost less overall. A 0% credit card offer can too, but check the balance transfer fee, when the promotional rate ends, and whether you'll be approved.
Options that do:
A first-time home withdrawal from an IRA. You can withdraw up to $10,000 over your lifetime from an IRA for a first-time home purchase without the 10% penalty, though income tax still applies to pre-tax money (IRS). 401(k)s don't have this exception. Other ways to reach retirement money early are covered in Tax-Advantaged Accounts: Why Use Them Instead of a Regular Brokerage Account.
Roth IRA contributions. Money you contributed directly to a Roth IRA can come out anytime without tax or penalty (IRS). You can put it back within 60 days as a rollover, once in any 12-month period. After that, it can only go back as a new contribution within the yearly limit (IRS).
An emergency withdrawal. Some plans allow one withdrawal a year of up to $1,000 for personal emergency expenses, without the 10% penalty (IRS). It's taxed as income, and you can repay it within three years. If you don't, you can't take another one for three years unless your new contributions make up for it (IRS).
A hardship withdrawal. Some plans allow it for specific needs. It's taxed and usually penalized, and unlike a loan, it can't be paid back.
How to Think About It
A 401(k) loan isn't good or bad on its own. It's a tool with a specific risk profile. The key question isn't only "can I repay it?" but "can I repay it even if my job changes?"
It can be reasonable when:
The need is specific and short-term, such as paying off a high-interest credit card balance or covering a one-time expense.
You're confident your job is stable for the length of the loan.
You could repay the balance quickly if you did leave your job.
The alternatives cost more, such as credit card debt at a high interest rate.
It's a poor fit when:
You'd be borrowing to cover ongoing spending. That points to a cash-flow problem a loan won't solve.
Your job feels uncertain, or you're planning to leave soon.
You'd need to stop or reduce your 401(k) contributions to afford the payments. Missing out on an employer match makes the loan much more expensive.
You'd be taking it for something that can wait.
Summary
A 401(k) loan lets you borrow from your own account, up to the lesser of 50% of your vested balance or $50,000, and repay it with interest to yourself, usually within five years. It can be a sensible bridge for a short, specific need when your job is stable, but leaving your job or missing payments can turn the unpaid balance into taxable income.
FAQs
How much can I borrow from my 401(k)? The lesser of 50% of your vested balance or $50,000, if your plan offers loans. If half your balance is under $10,000, a plan can allow up to $10,000 (IRS).
How long do I have to repay a 401(k) loan? Generally five years, with payments at least quarterly. Plans can allow longer for a loan used to buy your main home (IRS).
Does a 401(k) loan affect my credit? Generally not. There's no credit check, and the loan generally isn't reported to credit bureaus. Confirm with your plan.
What happens to my 401(k) loan if I leave my job? The plan may offset the unpaid balance, which counts as a distribution. If the offset happens within 12 months after you leave, you have until your tax filing deadline, including extensions, to roll that amount into an IRA or another plan and avoid the tax (IRS).
Is the interest on a 401(k) loan taxed twice? Only the interest, and only in a pre-tax account. You repay it from after-tax pay, and it's taxed again when you withdraw it in retirement. The amount you borrowed isn't taxed twice, and interest repaid into a Roth 401(k) isn't taxed again.
Is a 401(k) loan better than a hardship withdrawal? Often, if you can repay it. A loan isn't taxed if repaid on schedule and the money goes back into your account. A hardship withdrawal is taxed, usually penalized, and can't be paid back.
Transparency Note: I'm the human behind the keyboard — the ideas, stories, and decisions here are mine. I collaborate with AI throughout the writing process: brainstorming, drafting, smoothing out grammar and flow, assisting with research, and creating the visuals you see throughout my posts.
Disclaimer: The information provided in this blog post is for educational and informational purposes only. I am an AFC® (Accredited Financial Counselor) Candidate, not a Certified Financial Planner (CFP®), Certified Public Accountant (CPA), tax advisor, attorney, or Investment Adviser Representative (IAR). The content herein is not intended to be a substitute for investment, tax, or legal advice from a licensed professional. Always seek the advice of a qualified professional with any questions you may have regarding your individual financial situation. The opinions expressed are my own and do not represent the views of my current or former employer.
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