Taking out a 401(k) loan? Here’s what you should know

Written by: Janet Berry-Johnson, CPA
• Updated •8 min read
Top view of a woman working at home in the kitchen with financial papers, counting on a calculator, paying bills, planning a budget to save some money.Image: Top view of a woman working at home in the kitchen with financial papers, counting on a calculator, paying bills, planning a budget to save some money.

In a Nutshell

Taking a loan from your 401(k) can be a low-cost way to borrow money — unless you don’t pay the loan back as agreed. Defaulting on your 401(k) loan can have serious tax implications, so before you borrow make sure you have a plan for repaying your loan.
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If you need cash, borrowing from your 401(k) can be a resourceful way to quickly access some money.

A 401(k) loan lets you borrow from your own retirement savings, up to a limited amount, and pay it back over time. Unlike traditional loans, the interest you pay during that time goes back into your account. 

But you want to make sure you stick to your repayment plan — and consider the risks that come with losing or leaving a job while still paying toward your balance. If you miss a payment or leave your job, your 401(k) loan may be treated as an early withdrawal, which could affect the growth of your retirement savings and be subject to both standard and penalty taxes.

Some common reasons people may take out 401(k) loans are to pay for financial emergencies, pay off high-interest debt, cover medical bills and finance home improvements.

How does a 401(k) loan work?

If your employer provides a 401(k) retirement savings plan, it may choose to allow participants to borrow against their accounts — though not every plan will let you do so.  As long as you have a vested account balance in your 401(k) — meaning you’re entitled to the balance outright —  and if your plan permits loans, you can likely borrow against it.

Just like with any other loan, you’ll need to repay a loan from your 401(k) with interest within a set time frame. A key difference with this type of loan, though, is that you’re borrowing money from yourself — so you’re paying yourself back, with interest.

Pros and cons of 401(k) loans

Borrowing from your 401(k) can be helpful in the right situation, but like most financial decisions, it comes with trade-offs. Before you borrow, it’s worth looking at both sides of the equation to help you decide if it’s the right move.

Pros of 401(k) loans

  • No credit check required — Unlike a bank loan or credit card, a 401(k) loan doesn’t require good credit, so it’s easier to qualify.
  • You’re borrowing from yourself — The interest you pay goes back into your own retirement account, not to a bank or lender.
  • Flexibility without demonstrating need — A participant’s reason for borrowing from their 401(k) is deemed irrelevant as long as the loan meets the plan requirements. Therefore, you don’t need to prove hardship or need to qualify.

Cons of 401(k) loans

  • You’ll have to repay it sooner if you leave your job — If you quit or get laid off before the loan is paid off, the remaining balance might be due quickly and can get taxed if you can’t repay it. 
  • There may be fees — Some plans may charge service fees for loan origination or maintenance, so check the details before you apply.
  • You miss out on investment gains — The money you borrow isn’t invested while you’re using it, which means it’s not earning anything during that time.

Additionally, some plans don’t allow participants to make contributions while they have an outstanding loan. And if your employer offers matching contributions, you’ll miss out on those while you aren’t contributing to the 401(k) plan. Loan repayments aren’t considered contributions, so if the employer contribution is dependent upon your participation in the plan, you may be out of luck if you can’t make contributions to your retirement savings while you repay the loan.

That said, taking out a 401(k) loan isn’t necessarily a bad idea — it depends on your situation and your plan to repay the loan. Ideally, you should be able to reap the benefits that come with consistent contributions to your 401(k) plan over time. Weigh these pros and cons carefully so you’re making a move that’s ideal for your situation both now and later.

How to borrow from your 401(k)

If you’re considering tapping into your 401(k) for a loan, it helps to have a clear process in place to ensure that you’re positioning yourself for both short-term and long-term success. Knowing what steps to take will allow you to move forward with confidence.

  1. Determine if your plan permits loans. Not all 401(k) plans allow loans. To find out if yours does, review your plan documents or contact your plan provider.
  2. Know your loan limits. If your plan allows loans, the maximum amount you can borrow is the lesser of $50,000 or 50% of your vested account balance.
  3. Decide how much you truly need and why. Just because you can borrow a certain amount doesn’t mean it’s advisable. Think it through and borrow only what’s necessary, since it’s coming out of your retirement savings.
  4. Apply for the loan. Submit a loan application following your plan’s procedures. The application will outline the loan amount, repayment terms and interest rate.
  5. Repay the loan. Loan repayments must be made at least quarterly, and the loan must generally be repaid within five years, unless it’s used to purchase your primary residence.

How long do you have to repay a 401(k) loan?

Generally, you have up to five years to repay a 401(k) loan, though the term may be up to 25 years if you’re using the money to buy your principal residence. IRS guidance says that loans should be repaid in “substantially equal payments that include principal and interest and that are paid at least quarterly.” Your plan may also allow you to repay your loan through payroll deductions.

The interest rate you’ll pay on the loan is typically determined by the plan administrator based on the current prime rate, but it — and the repayment schedule — should be similar to what you might expect to receive from a bank loan.

What happens if you leave your job?

When you take out a loan from a 401(k), you may have no intention of leaving your current employer. But if you receive a better job offer, or are laid off or otherwise leave, you could be required to pay the loan back in full or face some serious tax consequences.

Employees who leave their jobs with an outstanding 401(k) loan have until the tax-return-filing due date for that tax year, including any extensions, to repay the outstanding balance of the loan, or to roll it over into another eligible retirement account. If you can’t repay it, the amount of money you still owe will be considered a “deemed distribution” and could be taxed as it would be if you were to default on the loan.

That means if you left your job in January 2025, you would have until April 15, 2026 (assuming no extensions) — when your 2025 federal tax return is due — to roll over or repay the loan amount. Prior to the Tax Cuts and Jobs Act of 2017, the deadline was 60 days.

If you can’t repay the loan, your employer will treat the remaining unpaid balance as a distribution and issue Form 1099-R to the IRS. That amount is typically considered taxable income and may be subject to a 10% penalty on the amount of the distribution for early withdrawal if you’re younger than 59½ or don’t otherwise qualify for an exemption.

What are some alternatives to a 401(k) loan?

When cash is tight, borrowing from your 401(k) plan and paying yourself interest may seem like a good idea. But before you borrow, weigh all your options. Here are a few.

  1. Consider a home equity loan. If you have equity in your home, a home equity loan may allow you to tap your home’s equity to qualify for a loan. This may be a good option when you need the loan funds for home repairs and improvements, as the interest on a home equity loan could be tax deductible.
  2. Consider a taxable withdrawal. If you need cash because of a financial hardship, consider a hardship withdrawal rather than a loan (what is considered a hardship withdrawal varies by plan). You’ll likely have to pay income taxes on the distribution, but you may qualify for an exception that allows you to avoid a 10% early-withdrawal penalty. There are disadvantages to hardship withdrawals, too, so make sure to do your research first. If your distribution is related to financial hardship from coronavirus, you may also be eligible to have the 10% penalty waived.
  3. Consider a personal loan. If your credit is good, you may be able to qualify for a personal loan with favorable terms. You can use the funds from a personal loan to pay for virtually anything. And since they’re typically unsecured, you don’t need to risk collateral to secure the loan.

FAQs about 401(k) loans

Why do people get 401(k) loans?

As long as a plan allows it, participants generally can borrow from their 401(k) for any reason that they deem necessary. Some plans may only allow loans for specific reasons, so be sure to check your plan’s rules before trying to borrow.

Is there a limit on 401(k) loans?

Plans can set their own limits for how much participants can borrow, but the IRS has set the maximum allowable amount to 50% of your vested account balance or $50,000, whichever is less. But if your vested balance is less than $10,000, then you may be able to borrow over the 50% limit.

When can you withdraw from your 401(k)?

You’re typically able to withdraw a loan from your 401(k) as long you have a vested balance. Your vested balance is the portion of your retirement account that you’re fully entitled to, including the total amount that you’ve contributed and your employer’s contributions that meet the vesting requirements. A vesting period refers to the amount of time that you must be enrolled in your 401(k) before given full access to the funds contributed. 

Note that an early withdrawal is different than a loan and may have tax implications, unless you’re at least age 59 ½, or qualify for another exception.

Next steps

Depending on your financial situation, a 401(k) loan could be a good option for accessing money to pay off high-interest debt or to cover a big expense. But in other cases, this type of loan could end up costing you, so it might not be the right choice. Remember that it’s not the only option, and you should always explore all possibilities before deciding what type of loan to pursue.

If borrowing from your 401(k) is your only option for accessing necessary cash, make sure you understand all the terms. It’s also important to have a plan for how you’ll repay the loan.

Finally, look for opportunities to pay off your 401(k) loan ahead of schedule by making extra payments when you can — for example, if you have a sudden financial windfall or receive a raise. The sooner you can pay off the loan, the faster you can get back to generating returns on your investment and the less you’ll have to worry about defaulting on the loan or facing a big tax bill if you leave your job.

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Use our 401(k) calculator to help determine how much money you may be able to save by the time you retire.

About the author: Janet Berry-Johnson is a freelance writer with a background in accounting and insurance. She has a bachelor’s degree in accounting from Morrison University. Her writing has appeared in Capitalist Review, Chase News &a… Read more.